A semiconductor device has a first substrate and a semiconductor die disposed over the first substrate. A conductive pillar is formed on the first substrate. A first encapsulant is deposited over the first substrate and semiconductor die after forming the conductive pillar. A groove is formed in the first encapsulant around the conductive pillar. A first passive device is disposed over a second substrate. A second encapsulant is deposited over the first passive device and second substrate. The first substrate is mounted over the second substrate. A shielding layer is formed over the second encapsulant. A second passive device can be mounted over the second substrate opposite the first passive device and outside a footprint of the first substrate.