I was actually going to write that I think that those who question the existence of separate Magic and Faerie Realms have a valid point, but didn't want to extend my post any further. I've always personally questioned the existence of a Magic Realm, and of the conception of magic as something somehow outside of or other than nature. Nature, I mean, in the sense that classical philosophers and renaissance magi would have used it, meaning creation, the world, or the cosmos, not in the way we would use it now of "out in the woods". The Magic Realm has always been the weakest (game and story-wise), the vaguest and most ill-defined of the realms, and the one least based in real-world medieval lore. In-game, magi can't agree on what it is, whether those who claim to have gone there actually did, or whether it even actually exists. The only really concrete, plausible idea about it is that it might be Plato's world of Forms. But then again, in an earlier edition of Faeries, one of the competing ideas of what Faerie is, is that it is the realm of Platonic Ideals, so that's a point in favor of them being the same.
A better theory of magic is that it is part of nature itself: the occult power latent in creation, and the magician draws it out through his words and other magical procedures.
“Magic is nothing but the whole course of nature. For whilst we consider the Heavens, the Stars, the Elements, how they are moved, and how they are changed, by this means we find out the hidden secrecies of living creatures, of plants, of metals, and of their generation and destruction; so that this whole science seems merely to depend upon the view of nature. This Art, I say, is full of much vertue, of many secret mysteries; it openeth unto us the properties and qualities of hidden things, and the knowledge of that which is secret; and it teacheth us by the agreement and the disagreement of things, either so to sunder them, or to join them together by the mutual and fit applying of one thing to another, as thereby we do strange works, such as the vulgar sort call miracles, and such as men can neither well conceive, nor sufficiently admire. Wherefore, as many of you as come to behold magic, must be persuaded that the works of magic are nothing else but the works of nature, whose dutiful handmaid magic is.”
-- Giambattista della Porta, Magia Naturalis, 1558
This doesn't necessarily need to negate the Platonic conception, but could complement it: the occult power present in nature is greater or lesser depending on its conformity to the Ideal. This idea is already present in the game in raw vis sources and magical beasts.
An in-world theory of magic could be that because God created the universe with His Words and through His Word, and Man was created in His image, words have inherent power. This also fits into the Greek ideas of Logos and Nous. Adam and Eve, if they were to govern the world and all that is in it, would have needed greater power than humans currently have, but lost it at the Fall. Magic, first taught to men by the Grigori, was a method to try and slowly regain some of that power.
On the subject of faeries as story devices, they can be and are story devices for us, as storytellers, without being story devices in-world. There's meta, and then there's meta-meta, so to speak. After all, all of the characters and creatures in Mythic Europe are story devices to us. But it seems to me that making them story devices in-world makes them much weaker and less interesting story devices both in-world and out. Sort of like how boring it is to listen to someone else tell you about his dream.
Faeries who seem to exist just to die, can be put down to the inscrutability of faerie purposes. It could be just part of the Game, and rigid adherence to its rules. It could be that, being immortal, they don't really die but just return to Arcadia and undergo metempsychosis. Perhaps they want to die because they are bored with their current form, and want to try something new. Immortality, after all, could get rather tedious.
There is a valid sense of their drawing vitality from humanity, without going the full way into their being projections of our psyches. There is a strong tradition of them not being able to reproduce on their own, but being able to interbreed with humans. It could be inferred from this that there is therefore something of a lack of change, newness, and vitality, and this is what draws them toward us, as we are almost nothing but those things. This can be done, however, without denying them objective existence. The experience they get from receiving love from us, or provoking anger in us, or just the entertainment value of playing games with us, is simply intellectual and emotional stimulation from interpersonal interaction. After all, we depend on each other, on human interaction, in the exact same way, without being subjective constructs of each other's minds.
Back on the topic of separate Faerie and Magic Realms, as you mentioned, the existence of separate classes of creatures for the two has always been a very weak point. There's no trace of such a distinction in any folklore or literature, that I'm aware of. As to the pagan gods, I don't think that equating them with faeries works very well. For some of them, like the Tuatha de Danaan, it fits. Others are clearly diabolic, such as Molech and the Baals, one of whom they've already included as an Infernal False God. Most of them are probably the Powers, Principalities, Thrones, Dominions, etc. Or rather, they are men's dim and distorted view of them.
We tend to think, in our mythological anthologies, of the pagan pantheons as fixed and definitive, but in practice they were not. The conceptions and cults of the gods changed over time, with progress, conquest, migration, and assimilation. We all know, I think, that when two pagan cultures came into contact, writers and thinkers would draw equivalences between their gods and the other culture's. So Romans would equate Thor with Jupiter and Lugh with Mercury. Or the god of a tribe or city would be joined to a pantheon when that tribe or city became part of a larger culture. The point being that the perception of gods was mutable, and therefore more the ideas of humans than the true nature of immortal beings, and from that fact the argument can be made that none of the ideas was exactly right. So, in-game, we could say that the real "gods" were actually Powers and Principalities, etc. Some of them fallen, some of them not. Athena, for instance, would be a representation of the tutelary spirit of the city of Athens. Some Christian and, I think, Jewish writers have postulated that for each city, tribe, and nation there is both a Divine and an Infernal Power, who wage war, and whose dominion is somehow linked to the holiness or sinfulness of that community of humans, either as cause or effect, or perhaps both. Of course, the Divine Powers would not have sought nor accepted worship. But the fact that misguided humans offered it does not mean that they received it.
So in the end, I suppose I would probably fall in with those who want to eliminate the distinction between Magic and Faerie. Four realms of power is a nice, square number, fitting into the conceptions of four elements, etc. This may be too radical a change, but I think it would be more interesting to separate Death, Undeath, and Necromancy from the Infernal, and have that be the fourth realm of power. This distinction exists in both Hebrew and Greco-Roman tradition. Gehenna/Tartarus are a different thing from Sheol/Hades. One is a place of flames, torment, and punishment, the other is a dark, cold, and empty semi-existence. Odysseus and Aeneus visited Hades, not Tartarus. Most ghosts in stories are more lost than malevolent. I know that bears an uncomfortable resemblance to the cosmology of certain editions of a certain other game, but even the erm...Magi Litoris are bound to get something right, occasionally, by accident. Even a broken clock is right twice a day.