By "His creation being within Him", I assume you mean panentheism.
Pantheism is the belief that the universe is god. This would be heretical. (Ask the court that excommunicated Spinoza.)
Panentheism (with an extra "en" in the middle) is the belief that the universe is of God, but that God is more than just the universe.
Panentheism is a fully accepted way of viewing Judaism, as per nearly all ways of reading Qabbalah. The question is how to understand the Lurianic concept of "tzimtzum". This is the notion that creation was less an act of making things as an act of G-d constricting His Infinity to that one option can exist rather than all of them. To "make room" in concept, not physical space, for existence.
1- Tzimtzum kepeshuto (tzimtzum in the simple meaning) -- G-d literally constricting His Essence. This is the position of the Yosher Leivav (1:1:12):
From these things, we have learned that one who takes pity on His Creator must think in his heart that tzimtzum is literal so that he doesn’t come to insult God’s honour and think that God’s essence is present in the lowly, dishonourable, physical and even in the lowest things, God forbid.
However, the overwhelming majority share variants the objection of the Shomer Emunim haQadmon (2nd dispute no. 35 ff.)
Anyone who wants to understand tzimtzum literally will come to make many mistakes and will come to contradict many of the principles of faith.
Since G-d cannot change, how could we speak of Him contracting?
So there are two basic alternatives, and the choice between them is one of the fundamental points of dispute between Chassidim and Misnagdim (those who fought the innovations of Chassidus).
3- The Chassidic approach is that tzimtzum is an illusion, and G-d being unchanging means it couldn't really have happened. In fact, we only think we exist as independent entities; and in reality only G-d exists. This is typified by the Tanya (Shaar haYichud vehaEmunah ch. 3):
... [E]very intelligent person will understand clearly that each creature and being is actually considered naught and absolute nothingness in relation to his Activating Force and the “Breath of His mouth” which is in the created thing, continuously calling it into existence and bringing it from absolute non-being into being…. The spirituality that flows into it from “That which proceeds out of the mouth of God” and “His breath” – that alone continuously brings it forth from naught and nullity into begin, and gives it existence. Hence, there is truly nothing besides Him.
There is a Divine Mystery here, since if our own existence is merely an illusion, then no one exists to be prey to that illusion.
3- Misnagdim objected to the implication that everything is G-d, considering it tantamount animism and tree worship. As the Vilna Gaon put it (in a letter dated 1796):
They call themselves Chasidim – that is an abomination! How they have deceived this generation, uttering these words on high: “These are your Gods, O Israel: every stick and stone.” They interpret the Torah incorrectly regarding the verse “Blessed be the name of the glory of God from His dwelling place” (Ezekiel 3:12) and also regarding the verse: “… and You give life to everything.” (Nehemiah 9:6)
There is a dispute about what the Vilna Gaon's own position was. His Asarah Kelalim (kelal #2) appears to say that tzimtzum was literal, in terms of the verb -- there was a real contraction. But the tzimtzum was of G-d's Will, not of His Essence, so the phrase "G-d contracted" is non-literal. And as we see, the universe generally runs by rules and laws of nature, and the Divine Will is usually hidden.
His student, R' Chaim Volozhiner, gives a resolution that harmonized these two positions.
In Nefesh haChaim (shaar 3 ch. 2 Rav Chaim) explains that calling Hashem “haMaqom -- the Place” is a rather limited metaphor. A literal maqom is a place or holder of an object without being the cause of its existence. However, if Hashem were to retract his Will from anything, it would cease to exist; He is the Cause of existing. Thus the understanding that his position is like the Tanya’s.
But in chapter 4, Rav Chaim discusses the literal absence of Kevod Hashem, and the first appearance of the word tzimtzum, at the beginning of ch. 5, reads “…צמצם כביכול כבודו ית’ שיוכל להמצא ענין מציאות עולמות וכחות ובריות נבראים ומחודשים — He ‘constricted’, as it were, His Blessed Kavod that He could bring into existence the idea of existing worlds, forces/potentials, and creatures that are created and newly made.”
It seems to me that Nefesh haChaim is describing a literal tzimtzum of Hashem’s glory which then causes the illusion of an absence His Essence. That tzimtzum includes the conception one gets from the Vilna Gaon's Asarah Kelalim which in turn causes the tzimtzum as understood by Chassidim.
This dispute about what is tzimtzum goes to the heart of panentheism. The Chassidic position is frankly panentheistic. The Misnagdic view sites somewhere in between, as
the universe is of G-d. but in a way that it isn't a full embodiment of His Will (and thus giving me room to have my own will).
