It may work partly, for example you should be able to update opie completely and many of the OZ system files, but that said some things will not be able to be updated - anything which is loaded to allow ipkg to run, the kernel, etc.
You really are better off flashing. The stuff you have on SD can simply be unlinked with \'ipkg-link umount /mnt/card\' and then once you\'ve flashed relinked with \'ipkg-link mount /mnt/card\' so you won\'t need to install everything again. That said, make sure you back up anything in /root - the PIM datafiles for example.
Simon