I have always cut back the siding 3.5" and installed vinyl windows with the flange. Seal it up with blueskin and positive laps. Trim around window and caulk to finish.

I usually am able to get building paper around the perimiter and wrap that inside the opening an inch or 2. Then the blueskin on the sill. Then install the window and l bluesking over the flange on the sides and then the top so end up with positive laps.