Houston had been in talks with the Tannadice side over a new deal but has decided against extending his contract on reduced terms.
The news was announced at a joint press conference with the Tangerines boss and chairman Stephen Thompson.
The 54-year-old was granted permission to speak to Blackpool recently but does not appear to be in the running for the vacancy at the Championship club.
Houston stepped up from his role as assistant to Craig Levein when he left to take over as Scotland manager in December 2009.
He led United to the William Hill Scottish Cup in May 2010 and will seek to secure his fourth consecutive top-six finish in the Clydesdale Bank Premier League before he leaves.
United released a statement as the media conference started thanking Houston for his services.
It read: "Peter has now advised that he has decided not to extend his contract, as it is in the best interests of both the club and himself to remove any further uncertainty regarding the position."
In the statement, chairman Stephen Thompson said: "We are all extremely grateful to Peter for all of his efforts over the last three years as manager and indeed in his previous role as assistant manager.
"In an ideal world, we would have had no hesitation in renewing contracts on a similar basis as originally provided.
"However, the world has changed in the last three years and we must re-align the cost base of the business to the new economic reality.
"We are certainly not the only Scottish football club, or Scottish company, taking such action to ensure the future of the business and all of its employees.
"Peter fully understood this, but felt that with the direction the club has to go in, he could no longer continue to take the club forward.
"He will remain fully committed to his role as manager until the end of the season and will then leave with our best wishes and grateful thanks."
Houston added: "First, I would like to thank the fans, players, staff and the board for their unbelievable support during my time here.
"I am sure that I can count on that support until the end of my contract.
"It is with sadness that I have arrived at this decision but feel that I have worked with the board to help them financially to reduce the debts and ongoing costs over the last three years and that there is a limit to how much we can continue to cut costs and continue to deliver what I want on the pitch.
"I understand and accept that changing circumstances mean that the board is under continued pressure to reduce costs, but I feel the time is now right for me to move on for a fresh challenge.
"I look forward to working with everyone at the Club to ensure we finish top six again as we have done for the last three years."
Meanwhile, Kenny Shiels does not believe his Kilmarnock side will gain any advantage from Peter Houston's decision to leave Dundee United at the end of the season when the Taysiders visit Rugby Park on Saturday.
Houston had been in talks with the Tannadice side over a new deal, but at a joint press conference with chairman Stephen Thompson today, he revealed he has decided against extending his contract on reduced terms.
Speculation began immediately with regards who would succeed the former Scotland assistant, with ex-United skipper Derek McInnes, who recently departed Bristol City, installed as favourite by one bookmaker.
Killie boss Shiels, though, insists the United players are too professional to be affected and will also be playing to impress their future boss, whomever it may be, when the Clydesdale Bank Premier League resumes after the winter break.
He said: "I think Peter has done magnificent there, but it won't affect the players because they have quality players right through the team.
"So I can't see it having an adverse impact on the team, they are too professional.
"I can see it having a type of 'let's play for our places because there could be a new manager who comes in who might not like us'.
"Dundee United played really well against us at Tannadice in the last game when it was 3-3.
"We were 2-0 up and 3-1, but they came back and got a goal at the end of the game and thoroughly deserved it.
"They have a fantastic team and great players."
Shiels may have more to be concerned about with his own squad after losing three players, with the threat of more to follow.
Stopper Michael Nelson completed his switch to Bradford yesterday, midfielder Liam Kelly joined Bristol City last week, while striker Rory Boulding has left the club.
"You obviously have to cut your cloth and I'm not going to complain," said Shiels.
"We might be affected the most but we can't start crying because it sends out negative energy, and we don't want that to happen.
"They are massive losses but there is an opportunity for others to step up. We have good people to come in.
"I am motivated towards getting young boys in to help develop their careers and the club accordingly. That's the motivation I have.
"There could be more players leaving. I have no problems with that. If a player wants to leave he can.
"But hopefully this is a good enough place for people not to want that."
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