Just to add a few more notes.
Firstly: make a backup of all your data a.s.a.p. "Any of your data that isn't in at least two places, you don't care about." This is doubly true of a system which has completely packed in on you once - you don't know what made it stop, and you don't know what made it start again, so you have no idea when it will happen again. You have been warned!
Secondly, when backing up your files, make sure you remember that your email also needs backing up, as does your address book and, possibly, your bookmarks. If you have favourite templates in Dreamweaver, or Photoshop Plug-ins then those need backing up too. You can't rely on a total disk backup doing the job for you, since your backup system may give you a total disk image. This is fine if you need to restore the disk the way it was. If, however, you decide to install a new OS then you don't want a total disk image, you need something from which you can extract the data files.
If you are using Firefox (and I hope you are) then I recommend MozBackup for all your data backup and transfer, for Firefox and Thunderbird - it can making moving a Thunderbird profile almost painless (yes, really!). Review and download at MozBackup at CNet
If you're going to be moving over to Windows 7, then you're going need a substantial amount of migration over and above the basic OS files. As rshaffer said, it is possible to use a dual boot setup, but I'm guessing that you may not have the hard disk space (judging by the rest of your spec) for two operating systems - especially one with the substantial footprint of the latest iteration of Windows (as opposed one of the leaner Linuxes, for example).
BTW to re-enforce what rshaffer said. Microsoft may sell you Windows 7 at an "upgrade price", but that doesn't mean that you can install it over XP. You'll have to have a completely blank partition, which usually means wiping your entire XP setup, including all your applications and all your data files. (If you have them in the same partition - I reckon that when God made partitioning software He intended us to use it to separate applications from data. Not everyone agrees, but many do.)
Then you have to start from scratch and install the new OS, and then Acrobat Reader and (possibly) unzip software, then all your drivers. These have come zipped and with important info in pdf format - which is why you need Acrobat Reader and unzipping software (both available as freeware), then you get your networking and internet setup (including a good firewall - many people use Zone Alarm, free to personal users and may have a Win 7 version out) on the new setup so that you can update your AV software (which will need to be a version for Win 7, I presume). Then add the rest of your utilities and applications, then all your app add-ons (Photoshop plug-ins, Excel macros etc), then all the other bits and pieces you forgot, and then your data files (unless they are on on your D: drive - see note on partitions above. I got a good piece of partitioning software off a disk on a magazine cover.)
Recommendation, then - first make sure that Windows 7 has drivers for all your hardware. It would be a nuisance to discover that your printer won't work with Windows 7, for example, or your old scanner. I read someone saying the other day, "Oh well, if you're upgrading to a new OS, you should always reckon on replacing at least one major peripheral - probably your printer." You might even find that there are no motherboard drivers - which would be a real PITA if you discovered it after you had wiped your XP setup.
Secondly, when you have established that there are drivers, download them ALL and save them all on a new CD/DVD for ease of re-installation. Thirdly, start NOW on making sure that you have the installation disks for all your applications, and all your favourite utilities (a major problem for me, as I'm a utilities junkie.)
While I'm on the topic of utilities - do download Sandra. It will tell you a [bleep] of a sight more than your CPU-Z does. For example, I have just run the very old version of Sandra (2004) on my old laptop. This is the first bit of the report on my CPU, it had a *lot* more detail later, which I've omitted so that you don't fall asleep reading this:
Model : Mobile AMD Athlon XP 2500+
Speed : 1.33GHz
Model Number : 2500 (estimated)
Performance Rating : PR1924 (estimated)
Type : Mobile
Package : Socket A PGA
Multiplier : 10/1x
Minimum/Maximum Multiplier : 6/1x / 14/1x
Generation : G7
Name : Mobile Athlon XP (Barton/Thorton) 1.6GHz+
Revision/Stepping : A / 0 (0)
Stepping Mask : A2
Core Voltage Rating : 1.200V
Min/Max Core Voltage : 1.200V / 1.400V
Maximum Physical / Virtual Addressing : 34-bit / 32-bit"
The "Mainboard Module" includes a couple of lines telling me about my RAM:
Memory Module 1 : Hyundai Electronics HYMD512M646DFP8J FFFF2190 1024MB 16x(64Mx8) DDR-SDRAM PC2700U-2533-700 (CL2.5 up to 167MHz) (CL2 up to 133MHz)
Memory Module 2 : Micron 8VDDT3264HDG-335C3 7508C23A 256MB 8x(16Mx16) DDR-SDRAM PC2700U-2533-700 (CL2.5 up to 167MHz) (CL2 up to 133MHz)"
and more about my RAM slots:
"Logical/Chipset 1 Memory Banks
Bank 0 : 512MB DDR-SDRAM 2.0-3-3-7CL 2CMD
Bank 1 : 512MB DDR-SDRAM 2.0-3-3-7CL 2CMD
Bank Interleave : 4-way
Speed : 2x 133MHz (266MHz data rate)
Multiplier : 1/1x
Width : 64-bit
Power Save Mode : No
Fixed Hole Present : No"
This sort of thing is invaluable if you need upgrade information.
Which brings me neatly to my next suggestion:
If you find that you have any shortfall of resources (including things like the mobo drivers) then you might consider investing in more RAM straight away, rather than in a new CPU. It can make a huge difference to the speed of your system, and is often recommended as the most cost-effective way to speed up a system. If you were planning on that anyway, then it might be an idea to try to bolster the RAM first and go for the new chip and new OS later. New RAM isn't as much fun - or as sexy - as a new processor, but it might be cheaper, and possibly more effective. If you're concerned about keeping to a strict budget (and I realise that paper rounds are not the stuff of which major upgrades are made), that might be the most efficient use of your resources.
Don't under-estimate the costs of a new chip - they can include a new heatsink and heatsink fan, and you will need some thermal paste as well, though, if you get a retail package complete with heatsink then you will often get a small sachet of thermal paste with it. Look on the internet for instructions for using thermal paste - the corner of an old credit/store card (someone will have a recently expired one), or plastic bus pass is the ideal instrument for spreading it. Don't omit it - and if you can use your old heatsink, make sure you clean all the old thermal paste off first. Vinegar and newspaper might do, if you don't have access to special cleaners.
Oh yes, and you might need to check whether your power supply has enough oomph for your new CPU. Mostly they do, but old PCWorld computers were often rather meanly supplied in PSU department. The wattage is often to be found on the back, which means you needn't even bother getting the cover off, but do check.
I hope some of this is useful to you. Don't skimp on the boring bits when thinking about a new OS or a new CPU. Some issues, if avoided now can come back and really bite you in the bum.