120Gb full out of a total of 350Gb looks fine to me (or have I misunderstood?). That's easily 70% free space which is a very good figure to have (click here).
But if you'd like to see how XP runs on its own partition without your data, I'd suggest creating 2 partitions on the 350Gb drive: one 50Gb & the other with the remaining space (both primary). Install XP on the first partition & have the other partition only for data storage. It would also be wise to have another hard disk (internal/external) for data/backups only.
I have this setup with XP on a 20Gb partition, which I maintain at about 70% free space, while all my data resides on the other larger partition & another drive. I find the system very nippy this way. I suggested 50Gb for you as that should be enough for a while & any large program installs you may have. In any event, try to aim for an OS partition with at least 50% free space. G