It would be reckless to establish a Palestinian state now given the extreme levels of radicalisation that exist in Palestinian society and the close ties that Palestinian terror groups have with Iran. I agree that leaving millions of people in stateless limbo is unacceptable, but establishing an Iranian-proxy terror state on Israel's longest border would be a terrible outcome for the region. Aside from the risk to Israel, it would likely destabilise Jordan and lead to the takeover of that country by another Iranian proxy army, as has happened in Lebanon.
The best solution IMO would be Israel annexing the largest Jewish settlements in the West Bank and the rest of it becoming part of a Palestinian-Jordanian confederation, with Palestinian political representation (parties that espouse violence are proscribed) but Jordanian oversight of security. Jordan was the occupying power there between 1948-1967, and the majority of its population is Palestinian (Jordan used to be part of Mandatory Palestine). This new confederation would need to protect the rights of any Jews that chose to remain, just as Israel protects the rights of its Arab minority. There would also need to be a commitment to overhauling the education system, which currently teaches Jew hatred and martyrdom to Palestinian children. It's a moot point though, because the Jordanian government would rather set their hair on fire than get involved in this quagmire.
Failing that, I think steps to creating a path to a Palestinian state in the future, with careful oversight of all institutions by other countries (Saudis, UAE, US) is probably the only way forward. You cannot have a WB state develop the way Gaza did, with a terrorist group getting elected to govern, and then proceeding to spend all its energies on building a tunnel network under the entire civilian population so as to turn them into human shields for its terror activities.