Pena, 48, managed the Royals from May 2002 to May 2005, winning the American League Manager of the Year award in 2003.
"We are delighted to add Tony to our 2006 coaching staff," said general manager Brian Cashman. "His knowledge, passion and experience provide an awesome opportunity for this organization."
Pena led the Royals to an 83-79 record in 2003 -- Kansas City's first winning record since 1994 -- earning him awards from the Baseball Writers Association of America, Sporting News and Sports Illustrated as the AL's top manager.
The Dominican native had been planning on managing the Dominican Republic in next spring's World Baseball Classic, but Pena admitted that is now unlikely, as he will spend Spring Training with the Yankees.
"I believe it's going to be tough for myself and for the country," Pena said. "Anybody in baseball that joins a new organization, you need to be familiar with every player. With a lot of new coaches, we need to be there full-time."
Pena is the only Latin American presence on the coaching staff. Luis Sojo is moving to the Minors to manage Class A Tampa. The Yankees will look to Pena to help Robinson Cano in his sophomore season, as Pena is familiar with the second baseman from watching him play winter ball in the Dominican.
The five-time All-Star and four-time Gold Glove catcher will also serve as the catching instructor, a position held by bench coach Joe Girardi last season.
"I'm very excited," Pena said. "Coaches and managers are teachers, so we need to find a way to pass on our message and make sure it gets through. [Jorge] Posada has been in the game for a long time, but it doesn't matter how long you've been in the game, you still have a lot to learn every single day."
Pena posted a .260 career batting average over an 18-year career in the Majors, playing with five teams: the Pirates (1980-86), Cardinals (1987-89), Red Sox (1990-93), Indians (1994-96) and Astros (1997).
Pena ranks fourth all-time among Major League catchers with 1,945 games behind the plate, trailing only Carlton Fisk (2,226), Bob Boone (2,225) and Gary Carter (2,056).
Pena began his professional managing career in the Astros organization, managing Triple-A New Orleans from 1999-2001 and leading the team to a first-place finish in 2001. He held his first big-league coaching position in 2002, serving as bench coach for the Astros before taking the managerial position with Kansas City in May.
He admitted that he would like to get another shot as a manager in the future, but for now, he is happy with his newest challenge.
"There's no question that you always want to manage," Pena said. "I managed once, but right now, what I want to do is to coach for the New York Yankees."
The Yankees now have two vacant spots on their coaching staff, though Ron Guidry is expected to fill the role of pitching coach and Joe Kerrigan is expected to be named the bullpen coach.