A friends with benefits relationship can be tricky to define. Usually, friends with benefits (a.k.a. FWB) means that people who know each other engage in intimate/sexual activity without really dating each other. Its different from hooking up, which tends to be a one-time thing with someone new.

How do you walk away gracefully?

Be honest, but kind. Explain your reasons for why you dont think the relationship can progress. Tell them that you want them to find someone who is better matched with them. Allow them to vent their hurt and their feelings.