The new deal will keep the 25-year-old at the club until 2013.
Torres joined Liverpool from Spanish side Atletico Madrid in a £20million deal in 2007.
Liverpool manager Rafael Benitez said: “Fernando is one of the best strikers in the game today and, at his age, can only get better.
“Every major side would want him in their team, but he has shown how much he wants to achieve success at Liverpool by committing his future to the club.
“He’s a special talent but still has the hunger to improve his game.”