The former New Zealand rugby league international and heavyweight boxing champion, who is hoping to win sevens gold at the Olympics in August, helped the All Blacks to successive World Cup triumphs in 2011 and 2015.
The 30-year-old said a call from coach Steve Hansen after last year's World Cup final had convinced him to stay in the 15-man game in New Zealand.
"I grew up as a league boy, I'm not going to lie," he told a news conference in Auckland on Wednesday.
"But now this is where my path is and it's an amazing feeling to be part of such a high quality team.
"I must admit when I first came back I didn't really know too much about what it means to be an All Black. Now I do. I consider myself a rugby player and I just love the environment."
Williams said family reasons were behind his decision to leave the Waikato Chiefs and play Super Rugby for the Auckland Blues, where he will be reunited with Tana Umaga, the coach who lured him from rugby league to Toulon in 2008.
Toulon were among the wealthy rugby clubs hoping to lure Williams back to France and he was also a long-standing target of Australia's Sydney Roosters, who he helped to the National Rugby League title in 2013.
"It's flattering and, as a sportsman, it's always good to have those options but I'm very happy with this deal," he said.
The new deal allowed him to continue playing sevens and keep boxing in the off-season, Williams added.
Williams is not in the New Zealand squad preparing for the June test series against Wales, having decided to commit fully to the All Blacks sevens programme.
He is, however, expected to be available for this year's southern hemisphere Rugby Championship as well as the end-of-year tour once his Olympics commitments end.
Williams has earned 33 test caps since his debut in 2010 but has had to play second fiddle at inside centre to Ma'a Nonu for much of that time, being preferred as an impact player off the bench.
With Nonu now in France and no longer available, Hansen said the recommitment of Williams, who has been brought into the leadership group at the All Blacks, would allow New Zealand to build another world class centre combination.
"I believe he'll only get better and better," Hansen said. "He could end up being one of the greats of our game."
(Reporting by Nick Mulvenney in Sydney, editing by Ken Ferris/Peter Rutherford)
