The remaining prisoners were marched from the jail after dark
The raid began early on Tuesday, shortly after UK and US monitors left the Palestinian-run prison complaining about lax security arrangements.
Dozens of Palestinians, including Ahmed Saadat, surrendered to the Israeli troops after dark.
Angry protests and a wave of revenge abductions followed the raid.
I see Israeli army bulldozers tearing away at the remaining walls of the prison
Jeannie Assad
BBC reporter
Explosions, smoke and anger
Palestinian leader Mahmoud Abbas, who has since cut short his visit to Europe, condemned Britain and the US for withdrawing the monitors.
UK Foreign Secretary Jack Straw said Britain had repeatedly raised concerns about the security conditions in the jail and gave a final warning about the monitors' withdrawal on 8 March.
An Israeli foreign ministry official said the army raid was necessary after Mr Abbas said Mr Saadat and other militants were about to be freed.
Deadly raid
"The operation was completed with success," the head of Israeli central command, General Yair Naveh, said.
An Israeli official said Mr Saadat and four other militants from his Popular Front for the Liberation of Palestine would be put on trial for the killing of Israeli Tourism Minister Rehavam Zeevi in 2001.
Earlier, two Palestinians were killed when scores of Israeli troops backed by tanks and helicopters burst into the Jericho prison compound.
Unrest broke out across the Palestinian territories after the raid began, much of it directed against Western civilians.
Thousands of Palestinians led by dozens of gunmen firing in the air marched through the streets of Gaza City into the evening.
Palestinian police ferried convoys of foreigners out of the Gaza Strip. A crossing with Egypt was closed for the day after EU monitors were evacuated over fears for their safety.
In Tuesday's incidents:
At least seven foreign aid workers and teachers were kidnapped, some of whom were later released
A Palestinian gunman was shot dead by security forces during the abduction of two French citizens and a Korean from outside a hotel in the centre of Gaza City
A Swiss national who works for the International Committee of the Red Cross was seized by gunmen at his office in Gaza
Gunmen set fire to a British Council cultural centre in Gaza City, among other violent attacks on UK-owned property
'Grave violation'
BBC correspondent David Chazan says the raid has sparked a major diplomatic crisis between Britain, the US and the Palestinians.
Mr Abbas, who is president of the Palestinian Authority, called the withdrawal of the prison monitors a grave violation of agreements.
The British Council was one of several targets for angry protests
Speaking in the UK parliament, Mr Straw confirmed that Britain had informed both the Palestinian and the Israeli authorities about the imminent withdrawal.
Mr Saadat has been in Palestinian custody since early in 2002 - and was moved to Jericho under international supervision in a deal to lift Israel's siege of Yasser Arafat's Muqataa compound in Ramallah in May of that year.
The following month the Palestinian High Court ordered his release, saying there was no evidence to link him to the Zeevi assassination.
He was elected to parliament earlier this year, and both Mr Abbas and the militant election victors, Hamas, had spoken of releasing him soon.
Ahmed Saadat, leader of the Popular Front for the Liberation of Palestine, and five other Palestinians surrendered after Israeli troops stormed the jail in the West Bank town of Jericho. Israeli general Yair Naveh announced that the operation was successful.

Israel accuses Saadat of involvement in the October 17, 2001, assassination of Rehavam Zeevi, then Minister of Tourism. The Palestinian Authority jailed Saadat in 2002, under the terms of an international agreement and under the supervision of monitors from the United Kingdom and the United States.

Israel launched the raid soon after the monitors left the jail complaining that the Palestinian Authority had given them insufficient security. Israel quickly arrested and searched many of the prisoners, but a few prisoners, among them Saadat, fortified themselves in the jail, even as Israel proceeded to bulldoze it.

Saadat is now in Israeli custody for the first time. Palestinian President Mahmoud Abbas complained that the UK and US monitors were responsible for the prisoners' security and that their withdrawal violated the international agreement.