He returned to the club in 2012 as a reserve team coach and was named assistant to caretaker manager Giggs for the last four games of the 2013-14 season after David Moyes was sacked.
"I am delighted that Nicky has accepted the role of head of academy," United's Executive Vice-Chairman Ed Woodward told the club's website (www.manutd.com).
"Nicky has the traditions and heritage of this club in his blood and he is the natural choice."
Butt's appointment follows the departures of youth academy director Brian McClair last June and last week's exit of under-18s coach Paul McGuinness.
Butt said he felt honoured to be given the role.
"As someone who learned his trade in the United youth set-up, it's a huge honour now to be given the chance to lead the academy and to instil its values and attitudes to continue to create future generations of Manchester United players," he said.
(Reporting by Simon Jennings in Bengaluru; Editing by Peter Rutherford)
