A semiconductor device has conductive pillars formed over a carrier. A first semiconductor die is mounted over the carrier between the conductive pillars. An encapsulant is deposited over the first semiconductor die and carrier and around the conductive pillars. A recess is formed in a first surface of the encapsulant over the first semiconductor die. The recess has sloped or stepped sides. A first interconnect structure is formed over the first surface of the encapsulant. The first interconnect structure follows a contour of the recess in the encapsulant. The carrier is removed. A second interconnect structure is formed over a second surface of the encapsulant and first semiconductor die. The first and second interconnect structures are electrically connected to the conductive pillars. A second semiconductor die is mounted in the recess. A third semiconductor die is mounted over the recess and second semiconductor die.