It's hard to clarify the ending because for the entire show, most viewers were watching to 'understand'. There is nothing to understand, but there is a lot to 'feel'. The final episode is open to the interpretation of whoever is watching it, and in my opinion, the ending fit the series absolutely perfectly. There were some minor things, like the ending seemed a bit too 'easy' (such as, yay happy ending, we all go to heaven!) to try and please the fans. In reality, it's the little things that the finale did that truly made it 'the end'.
Yes, they all died. The sideways universe was not entirely purgatory, but a waiting room, parallel to the island. If you recall waaaaay back in the first season, Jack says to Kate "We all died three days ago", when the plane crashed, and it was time to start over. The island may have existed, it may have not of...in fact, the 'sideways universe' and island may in fact be the same, like heaven hell and the waiting room. The wait room was a place of dreams, where the characters who changed each other and themselves needed to meet one last time before they could all move on, as Christian put it. This is similar to the island, as they could not return to the island, or leave the island successfully, without everyone. Hence even though the Oceanic 6 escaped, they had to return to get the ones they left behind.
From the basic standpoint on what happened the island, it's simple...the heart of the island changed Smokey into...well, Smokey, and Desmond put out the light so Jack could kill Smokey, then had to put the light back on so the island wouldn't sink.
The main focus, however, was on the flashsideways, because the show is about the characters, not the plot. The characters live rather unhappily because the island never existed, and thus, they never associated with the other Losties. In associating with them, they were all able to 'remember' how their lives changed and the people they loved, and thus, were able to move on. Christian says that everyone dies eventually, so that doesn't mean all of the Losties died together. Sawyer, Kate, Hurley, and Ben seem to live for a while, and for some reason, people like Frank and Richard aren't in the afterlife.
These flashsideways had the purpose of exploring just how much we as the audience care about the characters, so much in fact that as soon as Sawyer and Juliet recognized each other, I bet my bottom dollar a vast majority of the viewers cried their eyes out. To answer your question, yes, they all end up being dead, just like every other person in the world. What mattered was the life they lived, who they changed, and how they themselves managed to change to live happier lives and/or find purpose in being who they are.
And I vote Matthew Fox wins an Emmy. Seriously.
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