Terry was offered a deal worth significantly less than his £150,000-a-week salary while he will no longer be a first-team regular.
His head was turned by offers in China but the 35-year-old has decided to stay following discussions between him, new boss Antonio Conte, Roman Abramovich and the board.
The news was announced on the official club website this morning.
A statement read: “Chelsea Football Club is delighted to announce John Terry has signed a new one-year contract.”
Captain Terry paid tribute to the Stamford Bridge fans after penning the deal.