Daley had been considered a possible favorite for the Democratic nomination.
Daley told the Chicago Sun-Times he had been overwhelmed by support for a possible bid, but he needed a break from politics. He served last year as campaign manager in former Vice President Al Gore's quest for the White House.
"It's just not the right time," Daley, 53, told the newspaper. "It would be a great honor to serve as governor of Illinois. But at this stage in my life, I have to do what is right for me and my family."
Daley and his wife, Loretta, recently announced their separation. He did not return calls for comment Tuesday.
Although he had not formally announced his intentions in the race to succeed Republican Gov. George Ryan, Daley received strong support from leading Illinois Democrats, including state chairman Michael Madigan and Sen. Richard J. Durbin.
Daley, the brother of Mayor Richard M. Daley and son of former Mayor Richard J. Daley, also said he did not want to make the financial sacrifice to run. He recently became vice chairman and senior managing director of Evercore Partners, a New York investment banking firm. Democrats see next year's race as their strongest chance in decades to reclaim a governor's seat that has belonged to Republicans since 1977. Ryan announced earlier this month that he would not seek a second term.
"Certainly, Daley was going to be a force, a huge factor in the governor's race if he chose to run," said John Gianulis, president of the Illinois Democratic County Chairmen's Association.
The 1998 nominee, Glenn Poshard, announced earlier this month he would not enter the race, and Durbin said he would seek re-election to the Senate.
Gianulis and other Democrats say they're not worried about the lack of a candidate whose name could clear the field.
Those who have announced or expressed interest in running include 1978 nominee Michael Bakalis, Rep. Rod Blagojevich, former state Attorney General Roland Burris, Cook County State's Attorney Richard Devine, state Rep. Louis Lang, former state Treasurer Patrick Quinn, Chicago attorney John Schmidt and former Chicago schools chief Paul Vallas.
Several top Republicans already have endorsed Attorney General Jim Ryan for governor. State Sen. Patrick O'Malley is the only other announced Republican candidate. Lt. Gov. Corinne Wood is also considering entering the race.
Brad Goodrich, executive director of the Illinois Republican Party, said Daley would have been a "formidable opponent," particularly with his fund-raising ability and the backing of his brother.
"I think they're left with a field of seven or eight dwarves at this point, so they've got a real problem on their hands," Goodrich said.