His forwards expertise will be put to use by director of rugby Steve Diamond and head coach Mike Ford, with Sanderson accepting he would be risking his long-term health by playing on.
"The problem is I have seven prolapsed discs in my back. Four of them have been operated on, but it's just too many for me to carry on playing," he said.
"I don't mind being sore after matches and getting injuries - that's something you expect as a professional rugby player. But it's when it starts to affect everything you do that you start to look at things.
"There is no short-term solution and the longer I play the more chance there is of causing permanent damage that will affect me in later life and even now I realise that I will still have to have more surgery at some point."
Sanderson won five England caps, scoring a try on his debut against Romania in 2001.
The coaching opportunity comes early in his rugby career, but Sanderson is determined to grasp it and repay Saracens for handing him the new position.
"I'm not going to sit around and feel sorry for myself and I'm really looking forward to the new role. I'll be working on contact skills, the tackle and ruck area and just trying to pass on what I've learned to the rest of the squad," he said.
"The decision to retire has been taken out of my hands and I'm delighted to have the opportunity to continue to work at Saracens and develop my coaching skills."
Diamond said: "It's always sad when a player is struck down with a chronic injury in the prime of his career."
England head coach Andy Robinson added: "On behalf of the England squad I was very sorry to hear that Alex has decided to retire fromÃ0Â playing professional rugby.
"But for injury I'm sure he would have received more caps for England and I'd like to wish him every success in hisÃ0Â coaching role at Saracens."