JPEG works just fine. Lots of people prefer PNG. Personally i can't see any difference between them when using them in Vegas. Just make sure you use a low compression/high quality setting when saving them as JPEG so that you don't add pixelization and the "spiderweb" artifacts that come from highly compressing JPEG images.

Picture size is an important consideration. While Vegas can handle just about any size you throw at it, if you have too many pictures that are too large it can slow down to a crawl and sometimes even crash. The pictures don't need to be any larger than the frame size of the finished video. If you're making an NTSC DVD then the frame size is about 654x480 or 720x528 (take your pick, doesn't really matter). There won't be any quality improvement by using a larger image size ... *unless* you're planning on zooming in on the image. If you're going to zoom in on a portion that is 1/3 the height of the image then you'll want to start with an image about 3 times the frame size, something like 2100x1500 or so.