The West Midlands outfit are now in the hunt for their fifth manager since Mick McCarthy's departure last February following their decision to cut ties with Saunders, who took charge of just 20 games since his arrival.
A statement on the club's official website said: "Manager Dean Saunders has been informed by Wolves that his contract is to be terminated. The decision has been made following confirmation of Wolves' relegation to npower League One. Assistant manager Brian Carey will also be leaving the club.
"Wolves have now begun a recruitment process, which, in conjunction with the Board, will be managed by Head of Football Development & Recruitment Kevin Thelwell. The club will now take as long as is necessary to make this crucial appointment and there will be no publicly communicated timescales.
"Wolves would like to thank Dean and Brian for their efforts in what has been a very difficult period for everyone, and wish them both the very best for the future."
Wolves have been relegated to the third tier of English football just a year after dropping out of the Premier League to the Championship.
The club's relegation was confirmed on the final day of the season with a 2-0 defeat to Brighton & Hove Albion.