United's under-18s coach Paul McGuinness resigned last week after 11 years at the club, who had been undertaking a review of their youth system since McClair's departure.
They have now moved to appoint Butt, 41, a member of the 'Class of 92' - the gifted group of young players that also featured David Beckham, Paul Scholes and Gary and Phil Neville.
Butt went on to play 387 games for United between 1992 and 2004, during which time he won six Premier League titles and won 39 England caps. He has also had stints at the club as reserve team coach and under-19s coach.
He was appointed assistant to caretaker manager Ryan Giggs for the final four games of the 2013-14 season following the departure of David Moyes.
Butt said: "As someone who learned his trade in the United youth set-up, it's a huge honour to be given the chance to lead the academy and instil its values and attitudes to create future generations of Manchester United players."
Executive vice-chairman Ed Woodward said: "Nicky has the club's heritage and traditions in his blood. He is the natural choice."
"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."
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