You most definitely need a physical device to test with--using the simulator is absolutely not good enough.

Just get a used (Intel) Mac Mini for a few hundred bucks. Not a huge investment.

No. (You could run OS X in VMware on Windows, but it's still OS X.)

You can test your app on iPod Touch as long as you don't care about the minor differences from the iPhone.

I'm worried about the expense, so this seems like a good way to go. What sort of specs do you need to run OS X under VMware?

A Mac running Leopard Server. If you want to keep it legit, at least.

Do you need to actually test on an ipod touch/iphone? The simulator isn't good enough?

If you want to test location and accelerometer events you will need to use an actual device. Also, the simulator does not place constraints on memory and processor usage so you will need to test on a physical device to make sure that you are not going to go over memory and crash or make an app that is so slow it's not usable.

The sim is good as far as getting your app going but if you do anything out side of a basic app, anything graphic or animation intensive. You have to use the device. The sim uses the same processor that it is run on which is way more powerful than an iPhone.

if you're going down that route, you can also dual-boot OS X.

You can't run osx in a vm without hacking it. aka: osx86.