Israeli Prime Minister Benjamin Netanyahu said in a cabinet meeting that the retroactive authorization of Havat Gilad, located west of Nablus city, will "facilitate orderly life there."
The outpost, established in 2002, is home to some 50 Israeli families.
Rabbi Raziel Shevah, a father of six, was shot dead from a passing car as he drove his car near the outpost on Jan. 9.
"Whoever thinks that through the reprehensible murder of a resident of Havat Gilad, he can break our spirit and weaken us, is making a bitter mistake," said Netanyahu.
The cabinet unanimously voted in favor of the legalization, a move that was already condemned by Palestinian officials.
Israeli authorities have approved plans for constructing thousands of new housing units in the settlements over the past few months. However, cabinet approvals for unpermitted outposts are relatively rare.
Ultra-nationalist Israelis have erected several hundreds of outposts across the West Bank. These outposts were built without permits from the Israeli authorities but the government often turned a blind eye to their construction.
There are an additional 120 settlements that Israel considered as legal.
Both outposts and settlements are illegal under international law as they were built on lands seized by Israel in the 1967 Mideast War, where the Palestinians wish to build their future state.
