I'm very confused about story progression. I thought that if I turned it off, my sims would only age if I was playing their lot. (It obviously didn't do that, and therefore I missed my first CAS sim's death.. ): ) What exactly does turning off story progression do? And if you turn aging off, does that apply to the whole neighborhood, or just the lot?

Aging is pretty self-explanatory...you've turned off aging in your neighborhood and no one gets any older. That doesn't mean the neighborhood stops evolving...story progression is the basis of people moving in and out of the neighborhood and such. It's completely seperate from aging. If you turn off story progression, everyone still ages, they just don't randomly move in and out of the neighborhood. You can always turn off both. :D

Is there anyway to make it Sims 2 style, where they age only if you're on their lot?

not by default as TS3 is not designed to be played like that
you might want to check out awsomemod and indie stone story progression mods
which have lot selective features, not sure if they'll do what you want them to though.

again the whole point of TS3 and the seamless neighbourhood is that everyone ages together so altering that maybe difficult

Not in the base game.

Awesomemod has a config setting to enable TS2 style aging.

aging is a content of story progression, without story progression the neighbourhood would not age, only the active household will age...without aging, no one in the neighbourhood will age but the story progression will continue...

From this blog on EA's official site: