Billions of pounds of health service and town hall budgets are to be handed over to the most vulnerable patients to purchase health and social care services in the community, in a dramatic change of policy being unveiled by the NHS's new boss.

Frail elderly people, disabled children and those with serious mental illness or learning disabilities will from next April be offered individual pots of money to spend as they see fit on health and social care services such as carers, physiotherapists and psychotherapy sessions, in an attempt, in part, to keep them out of hospital.

Some patients' budgets will be as little as a few hundred pounds, though most are likely to get more than £1,000, with a small number who have very complex needs receiving much more than that. Simon Stevens, NHS England's chief executive, said that it would help keep people out of hospital and ultimately save money.

Those allocated the funds would still get free GP and hospital care. Patients will not automatically receive cash payments into their bank accounts but will control the budget, which will be provided after a care plan is agreed with their doctors.

Stevens said that "north of five million patients" could each have a personal combined health and social care budget by 2018, paid for by "billions" of pounds provided by the NHS and local councils.

Stevens said the dramatic extension of patient power is needed to help ensure patients get a better deal from services many find frustrating to deal with, reduce unnecessary stays in hospital by keeping them healthy while still living at home, and also to overcome the shortages of money which are increasingly visible in the NHS and social care.

"We are going to set out the biggest offer to bring health and social care together that there's been since 1948 – a new option for combining them at the level of the individual," Stevens told the Guardian as he prepared to outline his ambitious plan in a speech to council leaders at the Local Government Association's annual conference in Bournemouth. It is his first major policy change since taking over in April.

The initiative is driven by "a widespread sense that our Balkanised health and social care services are no longer fit for purpose", Stevens said, especially when the ageing population has created growing demands for care just when Whitehall austerity programmes have created what he has called "two leaky buckets".

Diminished funding for councils has led to a reduction in the availability of services which traditionally have helped the elderly avoid ending up in hospital, as evidenced by a 124% rise in the last 14 years in the number of mainly older people needing to be admitted for a day or two as an emergency, he said.

The move is intended to improve the quality of care the four patient groups receive because at present too many of them receive inadequate and "fragmented" care. That happens because health and social care services often do not work well together and also because the NHS is not as good as it should be in giving patients with complex medical needs the joined-up care they need, he said.

Older people with several different long-term conditions can become baffled and daunted by dealing with an array of different parts of the NHS, including several departments of the same hospital.

Giving patients direct control over these sums of money is more likely to force health and social care services to provide more joined-up and user-friendly services than those two separate systems being merged, he said.

"Rather than arguing for a structural reorganisation, if Beveridge was alive today he'd clock the fact that, given half a chance, individuals themselves can be the best 'integrators' of the health and social care they are offered," Stevens added.

In his speech on Wednesday Stevens will make clear that his approach is completely different to his predecessor Sir David Nicholson's habit of telling the entire NHS to implement one set policy.

The new budgets will only be made available if local councils and GP-led NHS clinical commissioning groups in England agree to work together and fund them, he said.

While participation will be voluntary, he expects both types of bodies to set aside their usual mutual suspicion over which of them should pay for what elements of particularly needy people's care needs and make the budgets a reality.

"The proposition that we as NHS England are going to put on the table is that for those local authorities and local CCGs that want to work with us, we will jointly create combined, blended health and social care budgets for named individuals in each area", Stevens explained.

The Local Government Association and Age UK last night welcomed Stevens's plan in principle.

Katie Hall, chair of the LGA's community wellbeing board, said the 648,000 people who have personal budgets to help pay for their social care needs had got greater choice and seen their lives improved as a result. Today's announcement extends that to health needs as well.

But while council leaders will explore with NHS England ways to make care more personalised, the new budgets "will not resolve the structural problems in the health and care system or solve the funding crisis in social care", she warned.

Caroline Abrahams, Age UK's charity director, said: "At the moment negotiating the separate health and social care systems is for older people confusing, frustrating and slow, because they have to deal with too many people and keep telling their story to different people. For older people these personal budgets could mean getting the support they need, tailored to their needs, stop duplication and improve their quality of life."

However, the integrated personal budgets will need to be designed so that they do not "present confusing choices for some vulnerable older people struggling with illness or dementia" or make people feel pressurised into taking one up, she added.

Councillor Jim Dickson, Lambeth council's cabinet member for health and wellbeing, said that while most councils would welcome the boost to integrated care, "the crucial test of whether this will work is of course whether there is enough money in the new personal budgets to deliver quality care"

Jeremy Hunt, the health secretary, welcomed the plan.

"Better out of hospital care is essential for both patients and the long-term sustainability of NHS," said a spokesman for Hunt.