The decision is a blow for Chancellor Angela Merkel's centre-right bloc, particularly its socially conservative Bavarian branch that had campaigned strongly for the payments.
Critics say the monthly payments of 150 euros ($163) for children from ages 15 months to 3 years, instituted in 2013, discourage women from going back to work.
The constitutional Court in Karlsruhe said Tuesday that it's up to Germany's 16 states individually to make such payments, not the federal government.
The centre-left Social Democrats, who are Merkel's junior government coalition partners, say the 900 million euros reserved for stay-at-home parents should now be invested in early learning measures.
Germany has one of the lowest birth rates in Europe.