<p>People who have reached spiritual affinity can choose to leave all material things behind and leave their body to move to the spirit world, which is what Iroh did.
</p><p>I'd assume the reason why he knew who Korra was is because all spirits in the spirit world can simply sense who the Avatar is considering Korra is the bridge between the two worlds.
</p><p>Iroh was a very enlightened man who was already in touch with the spirits. It's not like Iroh being in the spirit world doesn't make any sense. I for one was very happy seeing him again since he was one of my favorite characters.
</p><p>And no, not everyone who passes away goes to the spirit world. I think people who have committed great crimes during their lifetime find themselves imprisoned in the fog of lost souls. Also enlightened people who choose to let go of worldly possessions can go to the spirit world (as we have seen Iroh do (but this is very rare)). So this is why we did not see Lu Ten. On a side note, I would have loved to see Zuko reunite with Iroh somehow after seeing Zuko's reaction to Korra conversing with him.
</p><p>Also this is just an anime.
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