When you disable overlay function the print screen function works and the snapshot function doesn't. the reverse is also true. Print screen just puts a copy of the image on your clipboard assuming you know what to do with it.
I'm not aware of a default directory called My Images in Windows. Of coarse you can always make this directory any where your heart desires. But the only way the directory would not be saved in VLC would be is you are not pressing the Save button, closing the player and then restarting VLC or the preferences files are corrupt.
Erase the preferences directory. C:\Documents and Settings\Owner (this is you)\Application Data\VLC Erase VLC.
Application Data is a hidden directory so you will need to make it visible.
The default within VLC is My Pictures and the image will be saved in PNG format. The best way to accomplish is from full screen mode pressing ctrl+alt+s a small picture will appear in the upper left corner of your screen (in VLC 0.8.5) and then fade away. A few users have expressed a need to press pause first, but to me this is optional.