An underpass would be created beneath the new park so that a large open space could be developed in front of the existing memorial.
Mr Key said the park would be a centrepiece of the World War II centenary and would commemorate the 100,000 New Zealanders who went to war, the 18,000 who died, and the 40,000 wounded.
The Australian Government was also planning a memorial for the park.
Minister of Arts, Culture and Heritage Chris Finlayson said the park would provide an opportunity to recognise military conflicts which did not have a national memorial in New Zealand, such as the country's ongoing role in peacekeeping.
The development of the site was expected to cost $12 million, of which the Wellington City Council would contribute $2.11 million.
The New Zealand Transport Agency would oversee the construction of the underpass, which was estimated to cost $70-75 million.
Wellington Mayor Celia Wade-Brown said the park would give New Zealanders the opportunity to commemorate fallen soldiers "without the noise of traffic".
A minute's silence was held at the unveiling of the plans for Lance Corporals Rory Malone and Pralli Durrer, who were killed in combat in Afghanistan's Bamiyan Province on Saturday.
Mr Key said the deaths "bluntly reminded" New Zealanders of the sacrifices servicemen made.