Xcode 4.2 comes with device support for iOS 4.2+ already installed. You don't want to change the base SDK, you need to change the deployment target. By default, the deployment target for a new project in Xcode 4.2 is set to iOS 5.0. You can change that either on the project settings summary screen or in the project settings configuration settings (it's fairly obvious on the summary screen, and just search for 'deployment target' on the full settings screen). Make sure you are using the full settings, and not just basic settings.
Also, make sure you haven't enabled any iOS 5+ only settings like Storyboards. Your project won't load on iOS 4.2 if those are enabled.
EDIT: Based on your comment, I think you may be using a 1G/2G iPod Touch? If so, it's the new default architecture. Since iOS 5 only runs on armv7 devices, the new default project only has armv7 as a valid architecture. Go to the project settings and add armv6 to the architectures and it should then run on your armv6 device again.