The objective of this research is to create a low cost non-contact automated tool setter to reduce the overall tool setup time for a micro-milling machine. The accuracy of tool setting has a direct impact on the outcome of machining. The research focused on addressing the tool setting in the Z-axis (spindle axis), which is needed for each tool change and accounts for the majority of the total tool setting time. A fiber optic FS-V30M sensor from Keyence that is equipped with a light emitting element and receiving sensor was used. The sensor detects the position of the micro-tool by measuring the light intensity change as the tool crosses the emitted light beam. A bracket was designed and manufactured to mount on the workpiece pallet to hold the fiber optic cable. A novel search/detection algorithm was developed and implemented in the CNC machine controller. Controlled experiments were conducted to test the performance of the tool setter. The system achieved 0.6 µm repeatability and 2 µm accuracy across different sizes of micro-tools. The execution of each tool setting takes about 10 seconds, which is 80–90% reduction from the manual tool setting.