The Independent Television Commission (ITC) drew 136 complaints from viewers who found it "offensive, shocking and in bad taste".
It starts with a woman giving birth to a baby boy who then shoots out of a window in a surreal sequence.
Viewers then saw the boy ageing rapidly as he flies through the air screaming, before violently crashing into his own grave.
The advert ends with the payoff: "Life is short. Play more."
Among the angry viewers were a pregnant woman and a new mother who objected to the childbirth scene.
Another woman who had lost a baby during childbirth said it was an upsetting reminder of her own experience.
The ITC was also told by 20 recently bereaved viewers that they found the advert particularly offensive.
'Positive statement'
Others who had suffered a major illness considered it to be insensitive.
Microsoft claimed the advert conveyed a "positive statement about life" but the ITC upheld the complaints and ordered it not to be re-shown.
The watchdog said that the man's screams "suggested a traumatic experience which, together with the reminder that life is short, made the final scene more shocking".
The ITC also reiterated its advice to the Broadcast Advertising Clearance Centre, which approves TV adverts before they are broadcast, to be more sensitive about themes involving death.
"Advertisements cannot be avoided by those who are grieving in the way that programmes whose content is flagged in advance can.
"In that context it considered that the final scene of a body smashing into its grave was unnecessary and had caused considerable distress to many viewers," it said.
A Microsoft spokeswoman said the advert would not be broadcast again but would continue to be used on the internet and in cinemas.
Blood-sucking mosquitoes
Xbox has followed Sony PlayStation's lead in opting for adverts which range from the unusual to the surreal.
Its first UK advert featured mosquitoes sucking blood in time to music.
The console has enjoyed only moderate sales since its UK launch.
By the end of June, Microsoft expects to have "shipped" between 3.5 million and 4 million consoles globally. Its original estimate was 4.5 to six million.