The former Manchester United player is aiming for promotion to the Championship which the Buckinghamshire club missed out on last season after defeat to Huddersfield in the play-off semi-final.
The 31-year-old was manager Karl Robinson's number one summer transfer target after he proved to be a huge hit with the fans during his loan spell at the club.
The midfielder had a short three-year spell in Manchester were he won the Premier League title and the League Cup.
His time at Old Trafford was cut short when he suffered a broken leg and dislocated ankle in 2006.
The former Leeds United player moved to Newcastle in 2007, and having regained fitness became a key member of the side.
Smith was part of the Magpies side which won the 2009-10 Championship gaining promotion to the Premier League.
The former England international expressed his eagerness at making the move permanent following chances at Newcastle becoming limited.
Smith made 18 appearances for the Dons last season, scoring once against Huddersfield and again versus Sheffield United.