A method of manufacturing of an integrated circuit packaging system includes: providing a base substrate; mounting a first die over the base substrate; mounting a second die over the first die; attaching an interposer substrate over the first die with an attachment adhesive therebetween, the interposer substrate having a central cavity and the second die within the central cavity; attaching a lateral interconnect to a second active side away from the first die of the second die and to the interposer substrate; and encapsulating the first die and the second die.