Tested out a set of armor in SMP on a vanilla server today : it appears that armor does NOT get damaged any more when hit. Also, a full set of iron armor reduces damage to to 20% of what it normally is. (a hit from a diamond sword does 5 damage to a naked player, 1 heart damage to a player with full armor)
And when you die, your armor is destroyed.
My admin won't spawn in diamond for a test : does diamond armor protect better than metal armor? According to the UI, it wouldn't, since full armor made from any material - leather, metal, or diamond - fills all of the armor hearts up.
Armor makes SMP survivable - a creeper explosion is just an annoyance instead of instant death, and I was able to fight whole groups of mods no problem.