I not sure if I've understood your problem correctly but my simple understanding goes like this.

The install to USB will, by default, reformat your USB (stick, drive whatever) as a single FAT partition. This allows the syslinux boot loader to boot Knoppix but restricts you to only a 4 Gb overlay file.

There are options that don't involve installing a boot loader, such as grub.

1. I started with a 16 Gb USB stick which I divided into two 8Gb partitions - the first one vfat and the second one ext3. The install to USB noticed this as asked if I wanted it to just copy the files and not reformat the USB stick. I said yes. This arrangement gave me effectively a FAT partition with a little over 4 Gb free for a large persistent store and a second 8 Gb partition I can used as a mounted file system. I dare say I could encrypt both if I wanted.

2. Under older versions of Knoppix, you could put your persistent store (overlay file) on a different device/partition from the one you booted Knoppix from. You can't with Knoppix 6 but you can cheat. For example, you could put a copy of the (large) KNOPPIX/KNOPPIX file on the linux partition and use the fromhd= cheat code to 'boot' Knoppix from there. Knoppix will look for your overlay file on the Llinux partition so you've got round the 4 Gb limit.

By doing a USB install of the CD (and not the DVD) you could get away with a FAT partition of only 1 Gb leaving you lots of room for the linux partition and the overlay. With a little more work you can get the FAT partition down to a tiny 8 Mb (yes Mb) but you may not want to go that far.