The 39-year-old former England international was on Leicester's books last season and helped them to the League One title, making 12 starts for the Foxes.
It originally looked as if Powell would be leaving the club, but boss Nigel Pearson has asked him to join his backroom staff, whilst also re-registering him as a player.
"Obviously I will not be looking to play too often and I am also taking one or two sessions which has been exciting and a great learning curve for me," Powell told the club's official website.
"I am going to be a development coach around the first team and also registered as a player so I have got the best of both worlds.
"I want to become a manager in the future and I don't see a better place for me to learn."