An imperfect system for your use case, for sure. An example where multi-user iPad would be great.
The whole iOS ecosystem is design with one user per device in mind. Apple ID, single user, etc.
There's a tremendous disconnect between how it should work and how it does work. If I want to put my device in "four-year-old mode", I shouldn't have to uninstall everything to get there.
However, they have started some work mainly focused on accessibility that might be good for this use. iPad only at the moment:
That said: I dislike the single user nature of the devices as well. I understand WHY they do it, but dislike it personally.
Also: iPodTouch costs about $200, which is the same as a handheld gaming handset from the likes of nintendo, etc, especially when looking at the different costs of games.
The password is not good enough, because multiple iTunes accounts can be on one device, and the kid could add a gift card to buy whatever.
I'm aware that the Touch is less expensive, but my argument is that "Just buy a separate device for your 4-year-old" is an insane line of reasoning, whether it's a $200 iPod or a $600 iPhone.