I also have the iPod Touch 2nd Gen and (model A1288) and upgraded it today, and as Ingo2711 correctly says, iOS 4.2.1 is latest update, and won't offer iOS 5. I've read elsewhere that the 2nd gen Touch wouldn't get iOS 5 support.
If it helps at all, we also have an iPad 1st Gen, and a couple of iPhone 4's (not 4s's). Initially I had the wireless sync turned on for the iPad, but then discovered it was actually much more of a hassle and slower getting my music to update (stays in cloud until you force it to download), than just syncing to iTunes which is quick and easy.
I've subsequently gone back to using iTunes to sync since it's pretty easy and it's really fast compared to syncing over the air. If the sync happened automatically over the air, then i'd be a bigger fan of that, but in the end, it just shows which songs are needed from the cloud, and you still have to click on the song to download it.
One thing we really like about iOS5 though is photostream, which automatically pushes photos taken on any of the devices to all the other devices, and does so automatically over the air -> they just show up.
For our 2nd Gen iPod Touch, to get a 'similar' photo stream behavior, I set iTunes to the sync photos to the Touch from my iTunes PC's photo stream folder. Thus, whenever I sync music to the Touch, then the latest photostream pictures get sync'd as well.