The deal includes a partial guarantee in the second year of the contract, league sources said.
The Pacers have $13 million left in salary cap space, a figure that could rise to as much as $17 million should Indiana rid itself of $4 million in non-guaranteed contracts.
In the aftermath of the Paul George trade to the Oklahoma City Thunder, Collison represents a dependable, stopgap point guard as the organization transitions to a youth movement, centered upon new center Myles Turner, Glenn Robinson Jr., and new Pacers Victor Oladipo and Domantas Sabonis.
The Pacers are still pondering whether veteran point guard Monta Ellis will be a part of next season's team, league sources said.
After three years with the Sacramento Kings, Collison returns to the Pacers, where he was part of playoff success from 2010 to 2012. Collison averaged 13.2 points and 2.2 rebounds for the Kings in 2016-'17.
ESPN front-office insider Bobby Marks contributed to this report.