What should I do about iCloud if I have a Mac with OS X 10.10 Yosemite and an iPhone 4 with iOS 7?
You are correct. From John Siracusa's extensive OS X 10.10 Yosemite review: (emphasis mine)


  Upgrading is not mandatory, but iCloud Drive completely replaces the old “Documents &amp; Data” item in the Yosemite’s iCloud preference pane. Applications like TextEdit and Preview won’t provide access to any form of iCloud document storage in Yosemite until iCloud Drive is enabled. You’ll be prompted to upgrade during the account setup process. If you decline, you can upgrade later by enabling iCloud Drive in the iCloud preference pane.


And Apple's KB page, specifically addressing iPhone 4 customers at the end:


  iPhone 4 customers
  
  iPhone 4 does not support iOS 8 or iCloud Drive. If you upgrade your iCloud account to iCloud Drive, you will not be able to use iCloud with Pages, Numbers, or Keynote on an iPhone 4. You’ll still be able to use the iWork apps on an iPhone 4, but without iCloud.


As for what you should do, I guess there aren't many counterintuitive answers here: Either get by without iCloud until you get a newer iPhone, or elect to use other syncing services like Dropbox, Box, or SpiderOak.