Spaniard Benitez, the former Valencia, Liverpool and Inter Milan coach, becomes the ninth manager under Russian owner Roman Abramovich.
He will be tasked with salvaging their season after a run of two wins from their last eight games left them off the pace in the Premier League and facing elimination at the group stage of the Champions League six months after winning the ultimate club trophy for the first time.
"The owner and the Board believe that in Benitez we have a manager with significant experience at the highest level of football, who can come in and immediately help deliver our objectives," Chelsea said in a statement.
The 52-year-old is due to meet the players at the club's training ground on Thursday, when there could be some interesting exchanges on the back of his lengthy and often fiery rivalry with Chelsea during his six years in charge of Liverpool.
During that time he won the 2005 Champions League, following the "miracle of Istanbul" when Liverpool came from 3-0 down to AC Milan at halftime to draw 3-3 and win on penalties.
They also reached the final in 2007, losing to Milan having beaten Chelsea in the semi-finals, and won the FA Cup in 2006.
At Valencia, Benitez won the Spanish league twice and the UEFA Cup but he has been without a club since being sacked by Inter in December 2010 after six months in the job.
Local media speculation on Wednesday was that Chelsea would appoint a temporary manager to fill the gap until former Barcelona boss Pep Guardiola potentially becomes available following a one-year sabbatical from the game.
