Wimbledon semi-finalist Kerber came through a gruelling 6-1 2-6 6-4 win over Czech Petra Kvitova to reach her fourth final of the year and her biggest yet.
Earlier, Williams, playing in her first semi-final since the 2010 US Open, was limited in her serve speed which was hovering around a slow 75 mph mark after picking up a back strain shortly before the match begun.
"Just in my warmup it was bothering me. I was like 'Oh, no'. I tried to fix it between the warmup and the match, but it didn't work," Williams told reporters.
"Right now I don't know why my back hurts, I just know it hurts. After this I'm going to get an evaluation and see what exactly is happening," said Williams, who will be keen to regain full fitness for the US Open later this month.
The American, who has comeback from illness this year, double-faulted on break point to go 3-2 down in the first set but, relying on her return game, she battled back to 5-5.
But another crucial double-fault on game point allowed Li to sneak back ahead 6-5 and then wrap up the set.
After receiving an on-court massage to her back, Williams roared back in the second set to win five consecutive games en route to taking it 6-3 to level the match.
But the exertion of her comeback cost her in the third set where she ran out of energy and was convincingly beaten 6-1 as Li went in for the kill.
Li, the ninth seed, is now a perfect 4-0 in her semi-final matches this year but has yet to win a final. Li's most recent loss coming at Montreal last week at the hands of Kvitova.
"It's amazing this year, because in the last two years I hardly got a point in North America. So I'm happy I can be in the final again," the 2011 French Open champion said.
Kerber's rise to seventh in the rankings this year, based on her rock solid defence, has included wins at the Paris indoors and Copenhagen events but her test against Li will be the perfect preparation for Flushing Meadows.
In an all-left-hander clash, the German dominated the opening set with Kvitova making a series of unforced errors but the gritty Czech dug deep to take the contest to a third, making full use of her powerful serve.
Kerber, though, swiftly regained her rhythm to race into a 5-2 lead in the decider against an exhausted looking Kvitova. The German was then broken as she served for the match before sealing the contest just before it reached the two hour mark on her next service game.
"I made a lot mistakes, and I knew that if I would play my solid game and go for the volleys I could win but I made a lot mistakes, that was the problem," Kvitova said.