I'm planning on taking early retirement (age 59 1/2) in two years. At
that time I expect my major assets and liabilities to be:

Assets
$600,000 - 401k investments
$500,000 - lump sum pension fund payout or $3,500/month annuity payments
$200,000 - home equity

Liabilities
$175,000 - 15 yr/4.75% mortgage with 12 years remaining on the payments

I have two (2) questions:

1. Under what circumstances is it advantageous to take the lump some
pension fund payoff over the annuity?

2. With regard to the mortgage, it seems to make sense that I continue
making payments on the loan for the tax write-off (I expect to
withdraw $80,000/year to maintain my current lifestyle). But I can't
help thinking there is a point of diminishing returns where I should
consider an early pay off on the balance. What, if any, conditions should
exist to make it beneficial to payoff the loan?

Thanks.

Keep the mortgage payment.  That write off is definately a plus... as
far as diminished returns go, the only thing you might not keep it for
is if you aren't itemizing your deductions anymore.  If the standard
deduction is as much as your itemized, then the loan is no longer
helping you out (although at 4.75% it's really not hurting you either
since you can get about that much in a completely safe investment).

Your life expectancy is about 28 years.
http://www.finance.cch.com/tools/downloads/04-lifeexpectables.pdf

Knowing that, your annuity is giving you about 6.5% interest.  6.5% in
retirement is respectable for a safe investment.  But if you are very
healthy and live beyond that 28 years then the annuity will really pay
off for you (giving you income longer than the annuity company is
betting on).  If you're less healthy and think you might unfortunately
pass away before their expected time then you should take the lump sum
and invest it yourself.  That way should you pass away you will have
more to leave to your relatives.

You're in a very good spot financially right now.  Congratulations! 
With guaranteed social security and your assets, $80,000 a year
shouldn't be a problem through the rest of your life unless you live
to a very old age.  Just be sure to not take any big risks with that
nice chunk of change you've built up through your hard work and good
sense.

One thing to consider... if you have any income from working at all
then you're eligible to contribute to an IRA up to the age of 70 1/2. 
That is a good way to avoid some of your taxes.

I'll agree with the gist of jack's comment (I tend to like the cut of
his jib on most answers).

Considering you have the option of holding > $1 million in assets in a
few years, I would recommend spending the money to talk with a
financial planner who can go over your assets in detail.

Depending on what you do with the mortgage and the pension decision,
you will likely need to change asset allocation in the 401k.

A competent asset manager can address income, asset and tax
considerations in one fell swoop. The best way to find a good advisor
is ask for recommendations from friends who are in similar financial
situations.

Beware of advisors who will "work for free"... they're likely
commission-driven and will try to steer you towards specific
investments. Long-term asset managers often charge you a small
percentage of assets under management, but they'll often do a one-time
consulation session if you're referred to them by an exisiting client.

Eaglesfan --

You've received some pretty good advice from Jack and Financeeco.  A
lot of this can be dealt with by sitting down with a financial adviser
and going over tax/payout scenarios.  They should be able to provide
you a good idea of what you can tap for a "risk free" income -- and
then allow some riskier investments like mutual funds to give you some
upside.  Note that I'm not implying that mutual funds are risky: Pres.
Bush wants privatized Social Security investments to go to mutual
funds, an indication that they're not "risky".  But rather a good
financial adviser should be able to rank the risks of investments,
from treasury bills to corporate bonds to index funds to mutual funds
to stocks to real estate.

In an environment where the risk-free long-term bond or Treasury bill
is yielding 4.80% -- with the Federal Reserve expected to raise rates
today -- your mortgage is probably more asset than liability.  After
all, after taxes you're paying less than 4.75% and if you took out an
additional $10,000 mortgage at the same rate you could buy Treasury
bills and actually make a few dollars.

But of course there are other matters to consider too concerning real estate: 
* What are alternate living options? 
* What other expenses are involved with the house?
* What are expectations for appreciation in the value of the house?

Financeeco's advice about paying a financial adviser is VERY sound. 
Consider strongly hiring a Certified Financial Planner -- someone who
is compensated for their advice rather than on commissions:
Certified Financial Planner Board of Standards
http://www.cfp.net/default.asp

Best regards,

Omnivorous-GA