I have a 4 year old DD who has been to disney at 8 months, 18 months, 2 1/2 and 3 1/2. The first trip, at 8 months, she was fine with the characters, had a great time. At 18 months she was scared to death and wanted NO PART of the characters. We didn't do any character meals that trip and we don't have a single photo of her with a character. We still had an awesome time.
At 2 1/2 she was still hesitant, but she had her baby sister with her on that trip who was 3 months old and we told her that she needed to "introduce" her sister to the characters. Once she had a "job" she seemed more comfortable interacting with the characters and we have some great shots of her and her sister with characters.
At 3 1/2 she was ALL ABOUT the characters and her 15 month old sister was less than enthusiastic...not petrified like her older sister had been, but she would have preferred to be left alone. Since I didn't want to rob older DD of the character experience, we couldn't simply avoid them for younger DD as we had with older DD.
What we found worked for us was to let younger DD warm up to the characters slowly. First day in the parks, we simply waved to the characters as we were passing by a greeting spot...no close up interaction, but she could watch them and get used to their size.
The next day, we let older DD greet some characters on her own, while younger DD watched from a distance. Later that day, we found a quiet spot in AK, Camp Minnie Mickey, where there were tons of characters and very few people. In fact, it was pretty much empty. We pushed DD up to the characters in her stroller and warned them that she was a bit hesitant. They were great at approaching her slowly and letting her warm up to them. They didn't move to touch her until she reached out for them. Rafiki was especially wonderful. He spent a long time with her, sitting down on the ground so he wasn't towering over her while she sat in her stroller.
On the third day we had a Princess character meal scheduled and it was her first time interacting with the characters up close. They weren't the fully costumed characters but they were still "strangers" to her, and she was OK with them. It helped that her sister was bouncing around yelling "Cinderella!" "Belle!" etc.
Next day we FINALLY did Chef Mickey's and while DD was still hesitant, she tolerated them coming up to her and taking photos.
To be honest, if I only had the one child and he/she was truly afraid, I'd just avoid the characters. I had all these wonderful images of my toddler running in to Mickey's arms for the perfect photo but I had to realize that that was MY wish, not hers. It's supposed to be vacation...it's supposed to be fun. If all of your shots are of your toddler screaming in fear, it's not worth it in my opinion. We really did still have a great time on our completely character free vacation when oldest DD was that age.
Good luck...hope your little guy warms up!