Allon died of heart failure in Afula on 29 February 1980. He was buried on the shore of Sea of Galilee in the cemetery of Kibbutz Ginosar (Kibbutz Ginosar Cemetery) in the Northern District. The funeral was attended by tens of thousands of mourners, with condolences extended by many world leaders, including Egyptian president Anwar Sadat.
As Operational Commander of the Southern Command he was responsible for security along the borders with Egypt and parts of Jordan. On 4 June 1949 he declared a 8 kilometres (5 mi) wide closed military zone along the border.
On 25 October 1949, while he was out of the country, Allon was replaced as OC Southern Command by Moshe Dayan. Most of his Staff Officers resigned in protest. He retired from active service in 1950.
In January 1948, Allon helped form the left-wing Mapam party. However, after the 1948 war, Prime Minister David Ben Gurion told Allon to dissociate himself from the party, a rival of his own governing Mapai party, as he saw it as too left-wing and a threat to state security. In December 1948, Mapam co-leader Meir Ya'ari criticized Allon's use of tens of thousands of Palestinian refugees to achieve strategic goals.
After ending his military career, Allon embarked on a public political career. He became a prominent leader in Ahdut HaAvoda, which had split from Mapam in 1954, and was first elected to the Knesset in 1955, where he served until his death. He was a member of the Economic Affairs Committee, Constitution, Law and Justice Committee, Education and Culture Committee, Joint Committee on the Motion for the Agenda Regarding Sports in Israel, and the Foreign Affairs and Defense Committee.
Allon was the architect of the Allon Plan, a proposal to end the Israeli occupation of the West Bank with a negotiated partition of territories. The plan was presented to the cabinet in July 1967, right after the Six Day War. According to the plan, Israel would retain one-third of the West Bank and protect itself from invasion from the east by a strip of settlements and military installations along the Jordan Valley. The mountain ridge west of this strip, which was populated by Arabs, would be confederated with Jordan. A strip of land flanking the Jericho-Jerusalem road, Gush Etzion and a large part of the Hebron Hills area, would be annexed. Minor territorial changes would be made along the Green Line, specifically in the area of Latrun. Allon also called for the development of Jewish neighborhoods in east Jerusalem, the rehabilitation of the Old City's Jewish Quarter, and the annexation of Gaza, whose Arab inhabitants would be resettled elsewhere.
Explaining the growing admiration for Yigal Allon three decades after his death, Oren Dagan of the Society for the Preservation of Israel Heritage Sites said, "people wish to live in the kind of state Yigal Allon dreamed of, for example on the Arab-Jewish issue. This isn't a post-Zionist approach, neither hesitant nor apologetic. It's an approach of safety and security that says, 'Our place is here,' but still emphasizes the importance of dialogue, and never through condescension or arrogance. Allon extended a hand in peace, and that's the approach we want leaders to adopt today."