New renters will be offered fixed-tenancy agreements of as little as two years, and could be evicted after that period if their financial circumstances have improved.
Housing charities accused the Government of penalising the poor, warning that the change will act as a disincentive for social tenants to earn more.
But housing minister Grant Shapps insisted the new arrangements will be fairer than the existing system, which has resulted in the waiting list for social homes almost doubling over the past 13 years to five million people.
The eight million existing social tenants will not be affected by the changes, which apply to England only and could be introduced as early as next year following consultation.
The plans are likely to inflame tensions within the Conservative-Liberal Democrat coalition. Lib Dem deputy leader Simon Hughes insisted the move to introduce fixed-term tenancies was the policy of neither the coalition nor his party when it was floated by Prime Minister David Cameron in August.
But Lib Dem communities minister Andrew Stunell today backed the plans, saying: "Liberal Democrats have always said we need to have a much smarter system that protects lifetime tenancies, but also provides the flexibility to ensure that help is targeted at people who really need it, enabling us to get more for every pound of taxpayers' money."
Mr Shapps said he expected contracts of a "significant length" - anything between five and 20 years - to be the norm under the new system, with some households continuing to get a lifetime tenancy. But the minimum contract will be two years.
Councils will be able to set their own rules on who gets on to the housing waiting list, and a new national home swap scheme will make it easier for tenants to move around the country to find work.
New tenants will have the right to pass on their home to a spouse or partner on their death, but will no longer be able to pass it on to other family members who lived with them.
Councils and housing associations will also be able to charge rent of up to 80% of the market rate, so that they can raise money to buy new properties.
Mr Shapps said that a "lazy consensus" on social housing had produced a system which helps far fewer people than it should.
"This out-of-date approach has seen waiting lists rocket and is unfair to people who genuinely need social homes," he said. "They trap existing tenants in poverty, often in homes that aren't suitable for them."
The reforms announced today would ensure that "those in greatest housing need are given priority", he said.
"It will also be more flexible, with councils and housing associations able to offer fixed tenancies that give people the helping hand they need, when they need it.
"But above all it will be fairer - councils will now be able to make decisions that genuinely meet the needs of local people, and the changes will not affect any existing tenants."
Mr Shapps insisted that the most vulnerable will be protected under the reforms.
But housing charity Shelter said the changes would do little to resolve a crisis which sees someone lose their home every two minutes.
The charity's chief executive Campbell Robb said: "The Government's response to our affordable housing crisis, both through these policies and those we have already heard on cuts to housing benefit, social housing investment and legal aid, has seen the poorest and most vulnerable in society penalised again and again in what begins to feel like a deliberate attack.
"In contrast, the millions of people constantly struggling with their rent or mortgage and many of the truly fundamental issues, such as a lack of new homes, the astronomical cost of housing and the insecure private rented sector, remain totally ignored."
Mr Robb called for the proposed minimum tenancy to be increased to five years, accusing the Government of "naivety" in thinking that people who have been homeless will be able to get back on their feet in just two.
Shadow housing minister Alison Seabeck said the plans would "worry both existing and prospective social housing tenants up and down the country".
"Council tenants are being told they may be forced to move if their income increases," said Ms Seabeck.
"That sends the wrong message to families trying to get on and could act as a cap on aspiration. And it hits those whose earnings fluctuate from year to year."
David Orr, chief executive of the National Housing Federation, agreed: "It's difficult to imagine a more powerful disincentive to do well than the threat of losing your home if you start earning too much.
"We must ensure that this does not happen. People need the stability and security of a safe home."
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