You really don't want to "upgrade" to windows XP from windows 98. First off, there's probably a lot of random stuff on the hard drive cluttering it up, unless you've been an absolute saint about drive maintenance, secondly you might want to upgrade to NTFS instead of Fat (but hey maybe not, I could see a reason not to) and third, you don't want any of your Win98 drivers to be hanging around after the upgrade. There's even some software that will not work in XP but does in 98, including some really common stuff like earlier version of Easy CD Creator and Norton Antivirus.
Another big thing: If that drive has been going for two years, you should consider the possibility that it might fail soon. When it does, you shouldn't have all your important data on it. You might consider getting a duplicate 40gig or larger drive and setting up a RAID-1 so that if it ever does fail, it won't affect your data at all. I wouldn't worry about it though if your data isn't that important to you, but if it is, keep in mind that the drive is probably past its warranty and approaching its mean-time-before-failure.
But whatever you do, even if you don't reformat it, at least delete all the Windows directories and Program Files directories and Temp directories, before you install XP onto it.