Yes that will work Andy. It just means that you're using their DNS zone instead of the one on your VPS. The alternative is to change the nameservers at 123 to point to your own nameservers. That way you can edit the DNS zone on your VPS for the domain directly.
Just replying to the 123 support issue, I did raise a support ticket about a week ago with 123 but am still waiting. Has anybody else tried to contact them recently? The
services@123-reg.co.uk email seems totally dead!