An embedded reservoir that provides an efficient nutrient removal system protects drinking water. However, embedded reservoirs are rarely used in eutrophic shallow lakes because of their undetermined nutrient retention efficiency and unknown effects by the phytoplankton community. In this study, we aim to investigate the nutrient retention and algae succession in an embedded reservoir and adjacent wetland from April 2017 to September 2018 in the eastern part of Lake Taihu, China. More than 40% of total phosphorus (TP) and 45% of particulate phosphorous entering the reservoir were retained semi-annually, and the highest TP removal efficiency was achieved in the reservoir during autumn with an average value of 53.3% ± 9.9%. The overall nitrogen retention efficiency (21.7% ± 37.8%) was lower than that of TP (41.8% ± 27.8%). Similar trends were obtained in the wetland area. An important pathway for phosphorus removal is through particulate matter retention. Our study revealed that nutrient retention mechanisms in the reservoir were primarily via macrophyte absorption, particulate substance sedimentation, and prolonged water residence time. Consequently, the phytoplankton biomass (Chl-a) in the reservoir decreased (from 48.0 to 25.2 μg/L) and water transparency improved, due to the decreased P level and transformation of the phytoplankton group into simple structures with good ecological status. Therefore, the combination of embedded reservoir and constructed wetland ecosystem can be used successfully to protect surface water. The results will be advantageous to groups seeking to preserve drinking water sources.