So my starting ML SS is in the last year of his contract and I probably won't bring him back. He's my best defensive option at SS and he needs to be in the lineup this year. I called up my top prospect this season (probably a season early, but whatever). He projects as an elite SS. My question is: If I start the prospect at 3B or RF this season, will I be retarding his growth as a SS defensively? Does the game penalize for this?

Nope.

Position doesn't matter, just games played.

I once used a starting catcher for several seasons who never caught a single game in the minors, he was DH only till the majors.

Yeah, my stud prospects will usually come off the bench or play DH while they're developing in the minors to reduce their chance for injury before hitting the bigs. Has 0 impact on development (or rather it actually has a positive impact on development because if they did get injured through higher usage playing their natural position [SS especially] it WOULD stunt their growth).