Scholz is widely expected to become finance minister and vice chancellor in the new government if the coalition agreement is approved.
After a gruelling marathon of negotiations, she managed on Wednesday to forge another "grand coalition" deal with the centre-left Social Democrats (SPD), who however extracted a high price.
Merkel's conservatives and the Social Democrats managed to reach a coalition agreement after the chancellor's attempt to forge an unorthodox "Jamaica" coalition with the pro-business Free Democrats and the Green party collapsed last December.
There are also concerns that a renewed grand coalition could provide a further boost to the German far right, with rightwing populist party Alternative für Deutschland set to become the biggest opposition group in the next Bundestag.
Ms Nahles said she would start campaigning at the weekend for members to vote "yes" to a coalition with Ms Merkel, who has led the European Union's most populous country and economic powerhouse since 2005. But expectations that she would take over with immediate effect on a caretaker basis until a party conference triggered resistance as it breached party procedure.
Mr Schulz said last week he would quit to allow the party to regroup and he recommended Ms Nahles as leader.
The hard-fought coalition deal is still subject to a ballot by the SPD's deeply divided base of 470,000 rank-and file members, who could yet sink the unpopular power pact.
Contrary to Schulz, an outsider for many SPD members, Nahles is deeply entrenched in the party.
"The SPD needs an organizational, programmatic and personnel renewal, and I wanted to facilitate that", Schulz told reporters in Berlin in announcing his retreat.
"The SPD is trying to calm the public with the change in leadership", said Carsten Brzeski, chief economist at ING-Diba in Frankfurt.
That leaves open who from within the SPD may take up that post.
CDU politician Roland Koch, a former premier for the state of Hesse, also appealed to Merkel to pave the way for a new generation of conservative politicians, naming Spahn and the more liberal-leaning Schleswig-Holstein state premier Daniel Günther as candidates.