The 41-year-old, who had a decorated playing career at Old Trafford over a 12-year period, has earned the position after working as reserve team and under-19s coach for the last four years.
Butt was a product of United's youth system himself and is looking forward to helping create the next generation of stars.
"It's a privilege to take on this role," Butt told the club's official website
"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
"It's a big challenge but I am fortunate to be taking over a dedicated, first-class team
Our aim remains the same - to keep supplying the first team with well-coached, rounded players that understand the responsibility of playing for the biggest club in the world."
United have restructured their set-up following the exit of director of youth academy Brian McClair last June and Butt's appointment comes after Paul McGuiness left his role as under-18s coach after 24 years in the role last week.
Executive vice-chairman Ed Woodward added: "I am delighted that Nicky has accepted the role of head of academy
Nicky has the traditions and heritage of this club in his blood and he is the natural choice to ensure that, in modernising the way the academy operates and shaping the new investment we are making, it retains the values and the focus that it has always had.
"Manchester United's academy is completely focused on producing young players for our first team
As a graduate of its finest team in the modern era, Nicky will bring passion, energy and experience to drive the academy forward, retaining the characteristics that give us a competitive advantage - namely an unmatched track record of player development together with the runway of first-team action.
"In the last four years, some 15 academy graduates have played for the first team, playing a total of 173 appearances - a record of which the club is very proud."
Butt made 387 appearances for United, winning six Premier League titles, three FA Cups and a Champions League.
Source : PA
Source: PA