You should always use the newest SDK as base SDK in your application. You can always target older iOS version with the "Deployment Target" setting, but you have to pay attention which new features you can use.
For example, iOS 5 brings two interesting new features, namely ARC and storyboards. You can use ARC if your deployment target is iOS >= 4.0, with the exception of weak references, which unfortunately do not work with iOS4. Storyboards are different, they need iOS 5, they won't work at all on older devices!
If you're using the newest XCode 4, you have to do some extra work to fully support iOS 4 or older versions. This is because the armv6 code generation has been deleted from all templates. Newer devices use the armv7 instruction set, but you can compile your application so that it targets both the armv6 and armv7 instruction set. See my other post on this topic.