The 74-Test veteran will continue to play for the Hurricanes and Wellington in Super 14 and provincial rugby and said the decision was based on wanting to spend more time with his family.
Speculation about Umaga's future surfaced before the Test against Scotland, the last step of the All Blacks' second Grand Slam, in Edinburgh in November.
Flanking Umaga at the press conference where he made his announcement were the All Blacks coaching panel of Graham Henry, Wayne Smith and Steve Hansen, New Zealand Rugby Union chairman Jock Hobbs and chief executive Chris Moller.
"It has been a tough decision but I think the time is right for me, for my family and for the team," the 32-year-old Umaga said.
"After the achievements last year and the development that is going on within the team, it is a good time to step down."
Umaga started his Test career as a wing, moving his way infield to end up at inside centre where he was a potent contributor to the outstanding All Blacks backline that has dominated world rugby over the last 12 months.
New Zealand enjoyed a 3-0 sweep of the British & Irish Lions, won the Tri-Nations and the Bledisloe Cup and completed the Grand Slam, a year unprecedented in New Zealand rugby history.
Henry admitted Umaga would be missed after having made an enormous contribution to the All Blacks and to rugby.
"Tana's legacy is immense - he has led the All Blacks with distinction and to great success, while making a major contribution to the development of All Blacks rugby and what it means to be an All Black.
"I am sad to see him retire given his performances in 2005 but he has taken the decision to spend more time with family and I applaud him for that.
"It is fitting that his record will be remembered along with the very best All Blacks' captains."
Smith, who had a long association with Umaga said: "Seeing Tana develop as a person is one of the abiding memories I will have from my All Blacks involvement.
"Tana has always cared about others and carried great responsibility for his own performance and that of the team.
"He has recently grown into an even greater leader, one who can share the responsibility with others whilst retaining an iron will and resolve to win."