When my older sister and I were old enough to stop believing, we had fun continuing the fantasy for my little brother. She's starting to notice that the Santa at the mall looks different from the Santa at the zoo. When she questions something, I usually ask her what she thinks is the explanation. If she asks me a direct question, I answer her honestly. But I don't believe playing with her in the Santa fantasy is any worse than reading her fairy tales, or stories with animal characters than talk and behave like humans.
Fantasies are part of childhood.
I think children are going to have fantasies whether you encourage them or not, and, unfortunately, some of their fantasies are sad or scary. Her fears are very real to her. It seems to me that if we can give children a few pleasant, happy, safe fantasies to go along with all the scary things they're imagining, we're doing something good for them. Encouraging kids to use their imaginations can help them develop their creativity and problem-solving ability. No matter how much cats fight, there always seem to be plenty of kittens.