Budgett has not featured at all for the West Country side this season after damaging his ankle in the club's Championship play-off semi-final win over London Welsh last May.
Capped 12 times by Wales, Budgett made 95 first-team appearances for Bristol since his move from Bridgend in 2005.
He will now remain at the club until the end of the season joining the Strength & Conditioning department as well as assisting forwards coach Matt Salter..
"Nathan has suffered a series of setbacks in his bid to regain full fitness, and following his second operation, the surgeon has advised him that he would not be able to play rugby again. Everybody at the club would like to thank Nathan for his contribution to Bristol Rugby over the last five years," said Bristol head coach Paul Hull.