I think you have to allow imagination be the designer and simply do the dangerous stuff yourself. I have a 5 and 7 year old and I make planes, wands, tanks, oojimaflips (generally offcuts hot melted together) and stuff you can only find in a childs mind. oh and ramps.
I am however seriously considering investing in some small but real basic tools and pre-cutting some softwood, then teaching my 5 year old the same as I was taught at school. bit young for the lathe though, maybe when he's 6 eh. It is nice to have them interested in using their hands at that age, especially if it keeps them off of the wii etc.