Mr Annan voiced hope that the “last difficult and frightening step” would be taken next week.
He has been leading talks between negotiators for President Mwai Kibaki and opposition leader Raila Odinga to end weeks of post-election violence that has resulted in more than 1,000 deaths.
“We are very close. We are moving steady,” Mr Annan told a news conference.
“We are on the water’s edge and the last difficult and frightening step, as difficult as it is, will be taken.”
US Secretary of State Condoleezza Rice is due in Nairobi on Monday to meet with the leaders and support Mr Annan’s mediation.
Mr Annan said the rival parties had agreed to review the constitution, improve electoral laws, bolster human rights, among other measures, to “address the root causes of the crisis”.
He said that “the only outstanding issue” remained the makeup of a coalition government. He said he planned to meet Mr Kibaki and Mr Odinga on Monday to “appeal to them to give instructions to their negotiators to really have the courage and make a deal”.
They are to sit down again with Mr Annan on Tuesday.
“We have defined the reform agenda for a new government and are now discussing the how and the mechanisms required for their implementation,” he said.
Mr Kibaki’s camp agreed to allow opposition members into government but only under the strong executive leadership of the president, according to a government official.
The opposition has pushed for the appointment of Mr Odinga as prime minister with full powers as head of government, a post that would require changes to the constitution.
Mr Annan has been seeking a power-sharing deal to pave the way for fresh elections, possibly in two years.
Mr Annan said: “I will stay as long as it takes to get the process at an irreversible point”, when “a new government is established”.
The sides also agreed to set up an independent review commission no later than March 15 that will investigate “all aspects” of the disputed elections and hand in a report in three to six months, said Mr Annan.
President George W Bush left last night for a six-day, five-nation Africa tour, but Kenya will not be included.