Yeah, there should be a gap of about 1/8" between the sensor and the ball. Yeah, the ball hitting the sensor will eventually break it, sadly. (Speaking from personal experience.)

There's no adjustment on the factory board, but may be on 3rd party replacements. Usually on this one, adjustment isn't needed because of the proximity of the sensor to the ball. (On other games, where there's a quarter inch of wood between the sensor and ball, adjustment is more useful.) If it's 'not always' picking the ball up, likely the cable between the controller board and the sensor board is loose, the pins not making good connection. One of the recommendations there is to remove the headers and direct-solder the wires.

Edit: I am also assuming that the linked game is TZ Twilight Zone, and not "TW" or Time Warp.

The sensor/switch should NOT be active when there is a powerball in Trough #1 position.

When the game is in powerball mode (NOT Powerball Mania), no, no ball will be allowed up in the powerfield.

Yeah, the game enters Powerball mode. Special animation, the game growls "Powerball" at you - all the same things it does when the powerball is released form the gumball.

OEM boards did not require adjustment, no.