Hello from the UK. I had the same problem with my 2003 M3, and was totally unimpressed with iTrip or similar and wanted a 'Hard-wire' solution into the back of the Sat-Nav system. I spoke to BMW in the UK who were clueless, and also talked to their aftermarket ICE installer... no idea.
Following an internet search I found this link:
http://www.mattmcnulty.com/325xi/DIY/aux_input.html
Which contains not only the BMW part numbers for the wiring harness, but also full photographic installation instructions!!! When you have finished, you get a neat little 3.5mm Stereo 'Auxilliary Input' Jack in the Glove compartment. With a 3.5mm Male to Male Stereo extension cable you can connect your iPod directly into the 'Aux' input on the cable loom at the back of the BMW E46 OEM Sat-Nav system, and an 'Aux' option appears on the display which you can select same as CD, Radio, etc. Whole thing cost about $50 and took less than 2 hours to install (being very careful... !)
Only downside is that you still have to use the iPod controls to change tracks, etc. but it is a huge improvement in sound over the iTrip type devices.
The installation is pretty easy, although the actual 'Aux' input connector (fitted and bound up into the wiring harness already...) which you clip into is pretty hard to access behind the Sat-Nav screen... That being said, I achieved the whole installation just by removing the glove-box assembly, there is no need to pull out the Sat-Nav screen unit from the IP.
Have a look at the link, and see if it meets your needs - I am totally happy with this myself.
I did find out about another system which replaces your Multi-disc CD Player in the trunk... This apparently DOES allow you to control the iPod from the E46 multifunction steering wheel, but there is no way of getting track information onto the Sat-Nav screen... Because of this didn't see the point in the extra expense.
Hope this is helpful,
Phil.
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