It is the first role he has taken since he was dismissed as a coach with Celtic two years ago, having assisted manager Neil Lennon for two years.
A player at the Glasgow club for seven years, Thompson also spent time in the Aston Villa midfield during his career. However, he has now crossed the city to become the under-21 manager at St Andrew's.
"I am delighted to have Alan on board in what was a very difficult decision with outstanding candidates," said Lee Clark, the Birmingham first-team manager who has also completed a move for former Hibernian striker Clayton Donaldson.
"His passion and desire stood out but also his knowledge of working at a club like Celtic - both as a player and a coach - where there are huge expectations. He has experience at all levels of coaching at senior level. We are delighted to welcome him to Birmingham."