Saunders is widely regarded as one of the club's finest managers, in particular steering the club to the old Division One title in 1980-81.
In a statement, the club said Saunders died at 3pm on Saturday. As a mark of respect, black armbands will be worn during Villa's Premier League clash with Leicester on Sunday
The Villa statement read: "It is the sad duty of Aston Villa Football Club to announce that our former manager, Ron Saunders, has passed away at the age of 87.
"He died earlier today, Saturday 7th December, at 3pm and his family have asked for their privacy to be respected at such a difficult time.
"Widely regarded as one of the club's greatest ever managers, he guided Villa to promotion in his first season in charge, lifted two League Cups and steered the club to a league championship in 1980/81.
"Against Leicester City tomorrow afternoon, the players will wear black armbands and, as a mark of respect, we will be holding a period of applause to mark his outstanding contribution to Aston Villa."
Villa midfielder Jack Grealish paid tribute to Saunders, saying on Twitter: "RIP Ron Saunders.. AVFC Legend."
The Birkenhead-born Saunders enjoyed a prolific career as a player, scoring 200 goals combined for Everton, Gillingham, Portsmouth, Watford and Charlton from 1951 through to 1967.
Upon retiring, Saunders immediately went into management, initially with Yeovil, before spells with Oxford, Norwich and Manchester City, and then taking over at Villa in 1974.
Saunders enjoyed eight years with the club prior to joining bitter rivals Birmingham, followed by 19 months at West Brom, concluding with his sacking in 1987.
He remains the only manager to have taken charge of all three Second City clubs.
League Managers' Association chairman Howard Wilkinson saluted Saunders' achievements.
He said: "I have always held Ron in very high regard and I have the utmost respect for his achievements throughout his career and, in particular, his committed service to the three midlands rivals.
"His record of reaching the League Cup final three consecutive times with three different clubs is testament to his determination and dedication to his profession.
"The thoughts of everyone at the LMA are with Ron's family and friends at this sad and difficult time."