Saudi foreign minister Adel al-Jubeir told Reuters all commercial ties between the countries would also be cut.
It follows attacks on the Saudi embassy in Iran by protesters angry at the execution of Shia cleric Sheikh Nimr al Nimr.
Sunni-led Saudi Arabia claims the killing was part of a war on terrorism - but it has sparked protests among Shia Muslims throughout the region.
In response to attacks on its diplomatic missions, Saudi has ordered all Iranian diplomats to leave the country within 48 hours.
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