Encapsulated beta cell transplantation offers a potential cure for a subset of diabetic patients. Once transplanted, beta cell grafts can help to restore glycemic control; however, locating and retrieving cells in the event of graft failure may pose a surgical challenge. Here, a dual-function nanoparticle-loaded hydrogel microcapsule is developed that enables graft retrieval under an applied magnetic field. Additionally, this system facilitates graft localization via magnetic resonance imaging (MRI), and graft isolation from the immune system. Iron oxide nanoparticles encapsulated within alginate hydrogel capsules containing viable islets are transplanted and the in vitro and in vivo retrieval of capsules containing nanoparticles functionalized with various ligands are compared. Capsules containing islets co-encapsulated with COOH-coated nanoparticles restore normal glycemia in immunocompetent diabetic mice for at least 6 weeks, can be visualized using MRI, and are retrievable in a magnetic field. Application of a magnetic field for 90 s via a magnetically assisted retrieval device facilitates rapid retrieval of up to 94% (±3.1%) of the transplant volume 24 h after surgical implantation. This strategy aids monitoring of cell-capsule locations in vivo, facilitates graft removal at the end of the transplant lifetime, and may be applicable to many encapsulated cell transplant systems.,© 2020 WILEY-VCH Verlag GmbH & Co. KGaA, Weinheim.