There are lots of nice places in the Algarve. Alvor, Lagos, Carvoeiro and Tavira are all great for families with children. Have a look at TripAdvisor forums to get further background.
If you're interested in going to Alvor, send me a PM and I'll send you on some further details.
We stayed in this 5 star hotel in Albuferia a couple of years ago when my kids were 4 and 2. Couldn't fault it. The family rooms had self catering facilities. Might be an option for you.