The former All Blacks lock was off contract following a three-year stint as head coach. He served as an assistant for three years before that, so the latest deal will take his stretch to eight years.
The 41-year-old, who played 82 games for Otago between 2002 and 2013, said he was excited to continue working with the team.
"I am really excited to extend my contract with Otago and continue the work we have been building as a group over the past couple years," he said in a statement.
"I am determined to take this team to the top, as I believe we’ve got the right fundamentals and raw talent to be able to pick up where we left off in 2022. Otago has a great team culture and working environment, which ultimately made this an easy decision for me to make."
Otago missed out on a spot in the playoffs this season despite boasting a side containing 23 players with Super Rugby experience.
That would have been seen as a failure by many fans, but Donnelly can point to success with the New Zealand under-20 side.
He led the colts through an unbeaten Oceania tournament this year and has accepted an assistant coaching role with the Highlanders for the next two years.
Otago Rugby Football Union chief executive Richard Kinley told the Otago Daily Times last week that initial findings from the season review had been positive around culture and environment, but a decision would be made at the end of the month.
Yesterday’s announcement came as a shock in that sense, but Donnelly’s reappointment will not have come as a surprise to anyone following developments.
Dunedin coach Will Henry has been appointed to the role of regional development coach.
Henry’s coaching experience extends to being involved in school, club and Otago’s amateur representative programmes.
He will be responsible for supporting the development of coaches across the province, and supporting the development of NPC players not involved in Super Rugby or the Otago Academy programme when Donnelly is on Highlanders duty.
He will also have an involvement in the Highlanders under-20 and development programmes.
Kinley said retaining Donnelly was a positive move for Otago rugby.
"Having Tom continue as our head coach provides some stability and gives him the opportunity to build on the development of depth and talent we have seen within the team over the last few years," Kinley said.
