McAllister was assistant to Gordon Strachan at Middlesbrough but had been targeted by Houllier, who signed him as a player during his time at Liverpool.
The former Scotland international, capped 57 times, was described by the new Villa manager as "my most inspirational signing" during his time at Liverpool and played a key role in the treble triumph of UEFA Cup, FA Cup and League Cup in 2001.
McAllister, who has also managed Coventry and Leeds, is joined in Villa's backroom team by Gordon Cowans.
The former Villa favourite, who was capped 10 times for England, joined Villa as an apprentice when he was 15 years old and in three spells at the club made a total of 527 appearances. He has been coaching Villa's youth for many years.
Rafa Gonzalez, who came to the club in the 2007-08 season as goalkeeping coach to the reserve team, will be goalkeeping coach, while Robert Duverne - who worked with Houllier at Lyon where they won back-to-back titles - will assist as coach/fitness coach.