The three will remain behind bars at least until the new trial begins. But their lawyers expressed cautious optimism that a quick retrial will lead to their eventual exoneration.
Thursday's ruling by the Court of Cassation, rights advocates said, exposed the highly politicized nature of their initial conviction and heavy sentences of up to 10 years in prison in a trial that they dismissed as a sham with no evidence.
The journalists, Canadian-Egyptian Mohammed Fahmy, Australian Peter Greste and Egyptian Baher Mohammed, have argued they were targeted because of the Egyptian government's political fight with Qatar, the Gulf nation that finances the Al-Jazeera news network.
The two countries have been at odds over Qatar's support of the Muslim Brotherhood, which Egyptian authorities have cracked down on ferociously since the July 2013 military ouster of Islamist President Mohammed Morsi.
Hopes have been raised that Egypt's government now intends to free the men because of a recent public reconciliation between Egypt and Qatar. A date for the new trial was not immediately set.
Canada's Minister of State for Consular Affairs Lynne Yelich hailed the move to a retrial.
"We welcome this decision and anticipate the new judicial process involving Mr. Fahmy to be conducted in a fair, transparent, and expedited manner," her office said in a statement.
"The Government of Canada maintains serious concerns with the judicial process that led to Mr. Fahmy's previous conviction."
Fahmy's brother Sherif said the family had expected a retrial would be granted, but were disappointed he was not released on bail until the new proceedings begin.
Under a recently passed law, Egypt President Abdel-Fattah el-Sissi has the power to deport the foreigners during their trial. That would allow Greste to go home and would allow Fahmy to go to Canada if he drops his Egyptian nationality.
Sherif Fahmy said the family had already submitted such a request and is hoping Fahmy will be allowed to leave Egypt with Foreign Affairs Minister John Baird, who is set to travel to the country in the coming weeks to push the journalist's case.
"We hope that his arrival to Cairo could mean an implementation of this deportation and hopefully he will take Mohammed back with him."
Baird has said he's met twice with his Egyptian counterpart in the last month, most recently in Bahrain, where he brought up the journalist's imprisonment. Baird has said he also met with Egypt's ambassador to Canada last month to discuss Fahmy's possible release.
Fahmy and Greste were arrested in a December 2013 raid while covering the wave of protests by Morsi's Islamist supporters. The three were charged with helping terrorists by acting as the Brotherhood's mouthpiece and falsifying news to destabilize Egypt.
In their initial trial, prosecutors presented no concrete evidence of a connection to the Brotherhood, only samples of the team's news reports on protests, among other stories.
Fahmy and Greste were sentenced to seven years in prison, while Mohammed got 10 years. All three argued they were arrested for just doing their jobs.
Since Morsi's fall, Egyptian authorities vilified the Al-Jazeera network as doing Qatar's bidding in supporting the Brotherhood and fuelling Islamist protests. The station denies the accusations.
The three journalists did not attend hearing at the Court of Cassation, which lasted less than 30 minutes. All three families expressed dismay the court did not immediately order their release on bail, but legal experts said the Cassation Court does not have the authority to do so, only the judge in the retrial.
Greste's lawyer, Amr el-Dib, welcomed the ruling.
"This is a very good and optimistic decision. It will give them a second round of litigation," el-Dib said. "Hopefully when we go to the retrial, we can defend the defendants and present adequate support to try to set them free."
Fahmy's lawyer, Negad al-Borai, said the defence lawyers based their argument on the fact that the first court has been set up as a "special court" for the specific case, which is against the law. Among other grounds of his appeal, he said the initial court based its verdict on the assumption that as long as the journalists work for Al-Jazeera, they are members of the Muslim Brotherhood group, in absence of evidence that shows the connection.
Egyptian authorities offered no immediate comment on the ruling.
Fahmy moved to Canada with his family in 1991, living in Montreal and Vancouver for years before eventually moving abroad for work, which included covering stories for the New York Times and CNN.
— With files from The Canadian Press