The England international, 24, joined the club from Manchester City for £42.5m in 2023 and has emerged as one of their key players.
Palmer has won the UEFA Conference League and FIFA Club World Cup in his time at Stamford Bridge and has scored four goals and provided two assists so far this season.
"Chelsea means a lot to me and I think the club is going in the right direction, so I'm delighted to sign and I'm obviously very happy," Palmer said.
"Speaking to the owners, to the sporting directors and obviously the manager, they gave me a lot of confidence so it was only right to sign.
"Speaking to players as well, everyone has the same ambitions. I feel like we win major trophies here consistently and I want to be a part of that and play a big role in it too."
Palmer is the latest player to extend their stay at the club after Joao Pedro and Pedro Neto signed deals until 2034 and 2036 respectively earlier this season.