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Does the Avatar just eat Iu’m .does the souls join Khaine or what

Fire needs fuel.

so they ceasse to exist?

In 40k daemons 'consume' souls, but there's plenty of stuff out there whereby daemons are conglomerations of damned souls and some can escape or separate themselves from the gestalt should the daemon be distracted or destroyed. I'd imagine it's the same for a 'tame' daemon like the Avatar as much as wild ones.

The answer is that no one knows. That's kinda the point of the sacrifice. The Young King volunteers for this "honor" not knowing what awaits him/her.
They could join the splintered conciseness of Khaine
They could be consumed by Slaanessh, but their life energies fuel the Avatar
Or worse, they could indeed cease to exist. And yes, this may or may not be considered the worse fate for a race of beings that are basically immortal (in soul if not body). It just depends on whether the same happens if they are consumed by She who Thirsts.

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Fairly sure most CWE would consider ceasing to exist over damnation.