Stephenson, a fan favorite, was due to make $4.3 million.
"This was a very difficult decision, but as free agency begins on July 1, we want to have flexibility so that we can prepare for all of our available options,'' Pacers president of basketball operations Kevin Pritchard said Monday.
The Pacers' cap situation is fluid because of Thaddeus Young's $13.9 million player option and Al Jefferson's partially guaranteed $10 million contract. The Pacers currently project to have anywhere from $10 million to $30 million in room.
The team hasn't closed the door on re-signing Stephenson once other free-agent priorities are addressed.