Palmer, who took her surname from an English actress she admired, was one of three daughters born to Dr. Alfred Peiser, a German Jewish surgeon, and Rose Lissman, an Austrian Jewish stage actress. She studied drama in Berlin before fleeing to Paris in 1933 following the Nazi takeover. While performing in cabarets, she attracted the attention of British talent scouts and was offered a contract by Gaumont-British. She made her screen debut in Crime Unlimited (1935) and appeared in British films for the next decade.

In 1943, she married actor Rex Harrison and followed him to Hollywood in 1945. She signed with Warner Brothers and appeared in several films, notably Clock and Dagger (1946) and Body and Soul (1947). She also periodically appeared in stage plays as well as hosting her own television series in 1951. Harrison and Palmer appeared together in the hit Broadway play Bell, Book and Candle in the early 50s and later starred in the film version of The Four Poster (1952). Harrison and Palmer divorced in 1957. They have one son, Rex Carey Alfred Harrison (born in 1944).

Palmer went on to play both leading and supporting parts in the U.S. and abroad. She was married to Argentine actor Carlos Thompson from 1958 until her death from cancer in 1986 at the age of 71.

A talented writer, she published her memoirs Change Lobsters and Dance in 1975 and a novel, The Red Raven in 1978.

Lilli Palmer is interred at Forest Lawn Memorial Park in Glendale, California.