I agree that it's important to be honest, without going into more detail than the child is ready for. One of dh's friends died in an road accident last year; the dds were 2.5 and 4.5 at the time and we explained that our friend (whom they knew) had been accidentally hit by a car and was hurt so badly that his body doesn't work any more and he died. We explained that that means we can never see him again, he's gone and can't feel anything any more and everyone is very sad about that, but we can still remember him and all the good things about him. Dh and I are atheists (friend who died was very atheist too), so we haven't said anything about heaven or afterlife though at a later stage I'll explain that many people believe in an afterlife.
DD2 still remembers our friend and spontaneously talks about him quite often (She brings the subject up), saying that he died she misses him and wishes he could come to visit again. I don't think she's quite grasped the permanency of death though, as the other day she suggested that maybe we could get him back with a fishing rod
DD1 (who's generally more reserved) hasn't talked about it much.
I read a while ago that children need to grasp 3 separate concepts to truly understand death: non-functionality (the body doesn't work any more); irreversibility (no coming back to life); and universality (everyone dies). I don't think I'd want to tell a child this young that everyone dies, though, unless they asked outright.
There is a consoling idea in the picture book 'No Matter What' (Debbie Gliori) where a child-fox asks the mother-fox if she will still love him when they're dead and gone, and the mother talks about how some of the stars in the night sky actually died a long time ago, but we can still see them shining and "love, like starlight, never dies".