The 36-year-old made 43 appearances and kept 11 clean sheets for the Hornets last season, after joining from Arsenal, as Gianfranco Zola's side reached the play-off final.
The Spaniard's last-minute double save from Anthony Knockaert's penalty in the semi-final against Leicester, prior to Troy Deeney's dramatic winner seconds later, went down in Watford folklore.
The Hornets lost the Wembley final to Crystal Palace but nevertheless Almunia has committed himself to another season in the Championship.
Zola told the club website: "It's fantastic that Manuel has signed a new contract for next season.
"His experience and influence are so important for us and the impact he had at Watford last season was magnificent."