User data is kept in very specific areas on iOS apps, and there are further areas (cache and tmp) where data can be stored temporarily which can be recreated on the fly (or by redownload) if required. Until iOS5 an update via the App Store would be a full reinstall, effectively, but preserving the user data area so that your updated Angry Birds would retain your high scores etc. Delete the app, however, and you delete these user areas as well, as they are unable to exist outside of the app (they are sandboxed, and not available via a filesystem like mechanism etc.
To secure these areas, backup via iTunes. The App (or the latest binary version of it) is stored as well as the user data. It's possible to download an app, create some data, back it up, remove teh app & data, then update the app from within iTunes without installing it on your phone, and then add the app back into your sync list, at which point it will push over the new binary and repopulate teh user areas with your saved data.
I believe from iOS 5onwards a "delta" upgrade is possible, whereby rather than reinstall the whole app over the top (retaining user data) you only download the bits that have changed, but I cannot find the exact details right now. Certainly future OS updates will happen in this way, and I am sure it was coming if it has not already come to app store downloads, both on the Mac and iOS app stores.