Yes, you are only suppose to baptize by proxy your ancestry line. You also have to have permission by the closest relative living to do the temple work or that the deceased has been deceased for 100 years.
We believe that not everyone is this life has the chance to learn about Jesus Christ and his Gospel. We believe that in the spirit world that there are those that are being taught the Gospel for maybe the first time or maybe the 7th time but as we do the "baptism for the dead" they have the choice to accept or not accept the work that is being done.
Here is a link that will explain it with scripture references. LDS Link Here
Sorry I do not know how to do those fancy links.
Elizabeth, about your second question honestly I think God will work all things out. I know that my children are sealed to my family but I also feel that we are all apart of a bigger family. I know that I want my children's birthparents to be a part of their lives now and in the next life.
Really we are all adopted.
Heather
p.s. I don't mind the questions because I love sharing about my church but what about other religions?