The 32-year-old Pennetta qualified for the biggest singles final of her career after a 7-6(5) 6-3 drubbing of an out-of-sorts Li.
Pennetta will face Radwanska in Sunday's final after the Pole avenged her loss to Romania's Simona Halep in Qatar last month with a 6-3 6-4 win on the Californian desert hardcourts.
Radwanska, ranked third in the world, sealed the first set with an ace after she broke Halep's opening service game but found herself trailing the second when the Romanian broke.
But the 25-year-old Pole regained control, getting back on level terms then getting a second break and serving out her victory to reach her first final at Indian Wells.
"What I was trying to do was play aggressively from the beginning of the match and just try to go for my shots," said Radwanska.
"I was lucky. I think I was serving better than other days, so that helped today as well. I think it was a pretty good match."
Halep took some consolation from her defeat as she will rise to fifth place in the world when the new rankings are released on Monday.
"It was a tough match," said Halep. "She played really well.
"She deserved to win today. Every ball was in for her, and I had to run a lot. I think I started the match a bit too soft. I was not ready to play.
"But she is a great player. It's always difficult to play against her. I wanted to find my way to play. I did, but (it) was too late in first set. She was better than me today."
Li was promoted to the women's seed in the absence of world number one Serena Williams but had struggled with her serve all week.
She had similar problems against Pennetta, coughing up eight double faults in the first set alone, as the players traded eight service breaks before Pennetta won the tiebreaker.
Li's serve improved in the second set but her forehand let her down as she started to spray shots all over the court and Pennetta seized her chance, sealing her victory with a backhand winner.
For Pennetta, reaching the final capped an incredible year for a woman who was primarily regarded as a doubles player.
Less than a year ago, her singles ranking had plummeted to 166 and she was considering retiring, before she made a fairytale run at the U.S. Open, reaching the semi-finals.
She also made the quarter-finals at the Australian Open in January, which Li won, and is now through to her first Premier Level final and first singles final of any kind since 2011.
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