Word is not good with custom page sizes. The simplest plan is to use the
next larger standard sized paper and position the 'envelope' with margins.
You can add your merge fields where you want them (envelopes normally use a
frame to hold the addressee information attached to the EnvelopeAddress
paragraph style, but you can use any means of putting the address where you
want including line feeds and indents if need be (anything that is except a
text box or the merge will not see your fields). Put your return address on
the page where you want it in relation to the margins and check with Print
Preview that it looks right. print a sample page to the printer to check
that it all works with an envelope, then merge away.

If you must mess with envelopes, see
http://www.gmayor.com/changing_envelope_layout.htm and
http://www.gmayor.com/Alternative_Return_Addresses.htm