Williams, who announced her retirement from tennis on Tuesday, was making her final appearance in Toronto. Earlier this week, she beat Nuria Parrizas-Dias for her first singles win in more than a year - the first on hardcourt in 18 months. That improved her win tally at the Canadian Open to 35, which is more than any other player.
However, the former World No. 1 failed to build on that, falling short against Bencic in the third round.
It was a repeat of the pair's result in their previous clash in the 2015 Canadian Open semifinals as Bencic improved to 2-0 against Williams. In the process, Bencic also became the first player to beat Williams twice at the Canadian Open.
Following her defeat, Williams bid a tearful farewell to the Toronto faithful, saying that she's "terrible at goodbyes" as she looked back on her memorable career.
"It's just been so memorable. You know, like I said in my article, I'm terrible at good-byes. But good-bye, Toronto," Williams said.
Earlier this week, the 41-year-old wrote an essay that was published on Vogue announcing her retirement from tennis after more than two decades at the top of the sport.
"I wish I could have played better, but Belinda played so well today" - Serena Williams
Serena Williams was looking to win back-to-back matches for the first time since Roland Garros last year. However, Bencic put on a fabulous performance and broke Williams twice as she pocketed the opener after 41 minutes.
With Williams looking far from her fluent best, Bencic broke again at 3-3 in the second before sealing victory after 77 minutes. She struck more winners (25-13) and fewer unforced errors (13-18) than the American, which was key to her victory.
Williams reflected on an 'interesting 24 hours' following her loss to Bencic, wishing she had played better as she congratulated her younger opponent.
"It was a lot of emotions obviously," Williams added. "I love playing here, I've always loved playing here. I wish I could have played better, but Belinda played so well today. It's been an interesting 24 hours."
The 23-time Major winner is expected to appear at the Western & Southern Open in Cincinnati next week.