I bought a black iPod Nano 16gb 5th gen and it's perfect for me. 16gb is adequate storage space for my music library and the form factor is very small so that I can tuck it in a "crawl space" next to the storage bin where no one can see it. No one would ever know it's there without pulling out the storage bin and fishing around for it. I bought a case for it to prevent any scratches.

The advantages of an iPod over an iPhone for me are that
1) Don't have to plug it in and and plug it out everytime I enter/exit the car.
2) Many times for the USB connection to work with my iPhone, I have to put it in airplane mode, which means I can't use the bluetooth connection.
3) Sometimes, I have to plug in and plug out the iPhone connection a couple times to get it to work.
4) On the other hand, the iPod connection works 100% of the time (at least for me). So now I have a permanent 16gb "HD" that has everything sorted the way I like.

There are some less expensive and very good MP3 players like the Sony 545, but I decided to pay extra for the iPod because of the compatibility with my iTunes library and the fact that the Lexus software is already designed to work specifically with the iPod. I found this to be a much more satisfactory, albeit a more expensive option, than the USB flash drive route.

One more note, I wouldn't pay an extra premium for an iTouch, since the iTouch adds so many more features (touch screen, browsing, etc) that you will never use if you plan to store it permanently in the car.