Dhurringile Prison, located near Shepparton, will also close in the coming months, as a 1200-bed Western Plains facility opens in Lara, north-east of Geelong.
Staff at both closing prisons will be given the opportunity to work in other roles within the justice system or accept redundancy packages.
Port Phillip is privately operated by global security company G4S and had its contract extended for 20 years in 2017.
The maximum-security prison is currently the state’s largest and is located in Melbourne’s west.
Minister for Corrections Enver Erdogan said the move was about “delivering better facilities” for people in custody.
“I want to thank our staff at Dhurringile and G4S staff at Port Phillip Prison for the vital work they do every day in keeping people in custody and the community safe,” he said.
“They will be supported during this transition and be provided opportunities to take up new roles.”
Frankston serial killer Paul Denyer along with Hoddle Street killer Julian Knight are among the inmates currently at Port Phillip Prison.
Port Phillip Prison will close by December 31 next year, with prisoners to be transferred over the next 18 months.