The world number one dug deep but was stunned 7-6 (7/5), 6-7 (4/7), 6-4 by Goffin in his opening match of the end-of-season finale, which he has never won in his illustrious career.
The Spaniard came into the tournament with doubts swirling over his fitness after pulling out of the Paris Masters with a knee injury.
Initially he showed no obvious ill-effects during a rollercoaster round-robin encounter in front of a supportive crowd but eventually his injury caught up with him and forced him to admit his season is over.
"No, I am off," said Nadal. "My season is finished. Yeah, I had the commitment with the event, with the city, with myself. I tried hard. I did the thing that I had to do to try to be ready to play. But I am really not ready to play."
"Is about the pain," he added. "I cannot hold with enough power to keep playing. I tried, but seriously it was a miracle to be very close in the score during the match. It really doesn't make sense."
Nadal said he would work hard to be ready for the start of the next season.
"I know what I have to do," he said. "I know all the things that happened in the past when I had these things, and I know the treatment that I had to do. I know the periods of time that I need to work. Then if the treatment works or not, we will see."
Nadal, 31, struggled to find his range early in front of a raucous crowd rooting for him and was broken twice in the first set by the Belgian seventh seed, who had lost their previous two encounters.
The Spaniard appeared to have earned a psychological edge when Goffin double-faulted while serving for the set and the match went into a tie-break but the Belgian re-found his focus to come out on top.
The second set went with serve until the eighth game, when Goffin broke to earn a chance to serve for the match, only for Nadal to break back.
Goffin had a golden chance to seal the match in Nadal's next service game but failed to put away a mid-court forehand on match point and the left-hander levelled at 5-5.
The Belgian composed himself to hold and then earned three more match points but Nadal, showing incredible grit and playing right at the limit, saved all three to take it to another tie-break, which he won.
In the decider, Nadal appeared to feel discomfort in his right knee as he went two breaks down but still he refused to admit defeat, recovering a break before eventually succumbing.
"It was a tough fight until the end," said a relieved Goffin.
"Rafa is one of the strongest players mentally on the tour. I am so happy to finally find the key to win this match. It is so special to do it here."
Nadal has won 75 singles titles in his illustrious career, including 16 Grand Slams and 30 Masters events but he has yet to triumph at the ATP Finals, played on quick indoor courts rather than his favoured clay.
Earlier, also in the Pete Sampras group, Grigor Dimitrov held his nerve to beat Dominic Thiem 6-3, 5-7, 7-5.
The elegant Bulgarian had the edge for most of an enthralling contest of one-handed backhands but admitted he felt "pretty nervous" in his first appearance at the ATP Finals.
The sixth seed, who has enjoyed the best season of his career, looked wobbly as he blew his chance to serve for the match at 5-4 in the decider only to hit back immediately as Thiem himself faltered and going on to seal victory on his third match point.
The ATP Finals feature the top eight fit male singles players and doubles teams that have accrued the most points throughout the 2017 season.
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