IOs is not updating on the iPod Touch – how can I fix it

If you have the 4.0 beta, you are able to download the 4.1 GM from developer.apple.com and use Xcode's Organizer or iTunes (by holding the option key when clicking restore) to choose the correct version of iOS (which is on the disk image you downloaded) to reload onto the iPod.

Yes, it can. My 2nd gen touch is running 4.2.1 just fine and dandy. (It appears that, like the iPhone 3G, they won't get 4.3, though.)

I'd recommend to download the 4.2.1 update from Apple directly and option-restore the update to your device.