Just wanted to check something... I recently noticed that there is a distinct gap between window and body panel pretty much all around the rear window. I can see that there is rubber lining (is there a different term?) between the window and panel but that it is relatively receded somewhat. Is this normal? Should the rubber be flush with the window and panel?

It's normal.
The rubber does not sit completely flush since this "gap" acts as a rain gutter for the water to flow down.

If you notice the "roof rails" (which run on the roof from front to back on either side of the car) drain into these gaps.