There are some unanswered questions and diagnose to follow through with.
- That needle bearing shows rust and could be seized up. Clean and lube or replace. If it will not spin on the crank shaft then you are pulling the chain on the bar also.
- With the starter off the crank spins around fine by hand. as it should. But earlier you mentioned that you put some oil in the cylinder. If there is extra oil or fuel it will still turn by hand ok. Add the starter and yank on it it will still hydro lock due to the faster rotation. It could be a bad bearing that is rotating offset to cause binding.
- You mentioned that it does not matter when pulling with the selector switch in the off position. This shows that the coil might be fine along with the timing of the flywheel.
- With the sprocket off and the needle bearing removed, put the starter on, leave the switch to the off position. Pull the starter rope and see if it will pull through.
- I would rinse the cylinder and crankcase with fuel mix to clean it out, then dry it all out. Air compressor is your friend.
- Clean the flywheel side and the coil pick up/flywheel magnets. That are gets really packed with crap and good time to do some cleaning for better airflow and helps prevent the seal under getting too hot and failing.