That big square cross section O ring needs to be in place. But if the bell housing face gasket was properly installed and the nuts torqued up to 50 fl lbs, water should not be entering. The face gasket is the first line of defense. the big O ring is a back up. Something is wrong. Pull your drive and see if the drive shaft bellows has water in it. If it's dry there is a leak somewhere else. Lots of possibilities. But if the leak started with this seal kit, start over.
Get a new transom seal kit and put it back together correctly. The water pump passage O ring should be stuck in place with contact cement. I do the same with that big O ring.