One of the club's all-time leading scorers, Houston started at shooting guard for New York between 1996 and 2005.
The 36-year-old returned to the team late last week, but likely would have had to been cut by coach Isiah Thomas, who already had a maximum of 15 players under contract.
Houston averaged 17.3 points per game during a 12-year-career in the NBA, but retired in 2005 because of chronic knee pain.
"While my body and my knees, in particular, feel fine, I know what is required for me to be truly effective in the NBA again, and it involves a timing and progression that would not be fair to Isiah and the Knicks right now," he said.
Houston played six minutes in his only preseason appearance at the Boston Celtics a week ago, then sat out at the New Jersey Nets in his final game in a Knicks uniform.