Rail pass and hiking suggestions

The Swiss Travel Pass is pricey. Without doing a detailed analysis (but you are welcome to yourself, it will take about 15 minutes of your time), I have found that the Half Fare Card always saves money if the Jungfraujoch is involved, more than a Swiss Travel Pass.

The Bernina Express goes from Chur, in south east Switzerland (Graubunden), to Italy. The completely opposite direction you are going. The train from Luzern to Interlaken is quite scenic, so you won't get short-changed.

There's also the Jungfrau Travel Pass, similar to the B.O. Pass, but focused on Lauterbrunnen/Grindelwald areas only, so it won't pay for trains from Bern or Lucerne to Interlaken Ost, but then it's also cheaper.
There are debates each week on this forum about which is better for what. All I'll say is that they often come out pretty close. Here's more on them:

http://www.swisspasses.com/railpass/swiss-regional-rail-passes/

You mentioned hiking, and here are the best hikes, in order from best to still very good.
1. Mannlichen to Kleine Scheidegg, about 1.5 hours. Save for the best day.
2. Schynige Platte to Bachalpsee to First to Grindelwald (last leg via cable car). This takes 6 hours so leave early since cable cars stop at 6pm. If you don't have that time, or weather is iffy, then go Grindelwald to First (cable car) and take the 45 min walk to Bachalpsee (Google image it).
3. Lauterbrunnen to Grutschalp (via cable car) then walk to Murren. From Murren you could go up to the Schilthorn, but check first if the mountain top is fogged in. There's a tv monitor in the Murren cable car station that shows the top. If fogged in on top, you could walk up the trail going up the hill diagonal to the cable car line, and end up at the restaurant and cows at Spielbodenalp.
4. On a dreary day you can walk or take the Postbus from Lauterbrunnen to Trummelbach Falls (Google image it). You can even see those falls in the rain, since they are inside the mountain.
All of this makes more sense when you study the maps:

http://ontheworldmap.com/switzerland/ski/jungfrau/jungfrau-summer-map.jpg

http://www.gimmelwald.com/pics/gimmelwald/hikemap.jpg

I believe a combination of a Swiss Half Fare Card and a BO Regional Pass will work well for you. Not cheap, but much less than full fares.

The HFC will serve you for the Zurich to Luzern route plus discounts on your Day 2 plans. The BO Pass validity starts in Luzern so your trip to Lauterbrunnen is covered. Days 3-4-5 and part of Day 6 are covered under the BO Regional Pass, and you get a discount on buying it because you have the HFC. You will still have to pay a stipend to go up the Jungfraujoch but it is less because of the BO Pass. You'll have to buy a ticket to Zurich from where your BO Pass validity ends, but again the HFC will kick in.

You can double check the value of doing both passes by creating a spreadsheet, which I have done several times to convince myself I am getting the best deal.

Shoe's recommendations on hiking are solid. We always do his #1 and #3. ALsong with #1 we visit Wengen and along with #3 we explore Muerren. Do heed the advice about weather and plan each day based on the previous day's forecast. Talk to the folks at the station about going to the Jungfraujoch if you are unsure about weather. We went up when it was cloudy between the valley and the mountain top. It was gorgeous at the top but you'd never have known it looking up from Lauterbrunnen.

Thank you for reply. I am leaning towards Half fare card (+JF pass may be). I saw the live webcams in Wengen and there is a lot of snow on the ground! What should I realistically expect in 2nd week of May?

I love Wengen and Murren in the Lauterbrunnen valley. Murren is more touristy but it has better access to hiking. We loved the North Face trail from the top of the Funicular back down to Murren. It is an easy hike, grab sandwiches at the Coop grocery store in town before heading out.

Mannlich to Kleinne Scheidegg is an amazing hike but is second to the North Face Trail.

Hiking trail info for adults with kids.
http://www.momstotszurich.com/search/label/Hiking/

One of our favorite day hikes is from Murren to the Rotstock mountain hut. This hike is about 12 kilometers, round-trip, with wonderful views all the way. It has one steep climb and a few rocky descents, but nothing technical or too strenuous, and the views looking out from the Wasenegg ridge across the beautifully desolate valley toward the Schilthorn are worth it. On the trail out, stop at the cheesemakers hut at Schiltap. Then have a leisurely lunch at Rotstock hut before you head back to Murren via the ridge trail that descends to Spielbodenalp and Gimmeln, where you can have an afternoon coffee and kuchen. Another one of our favorite hikes from Murren is Stechelberg to Obersteinberg and Oberhornsee.
For other hiking choices get a copy of Kev Reynolds book "The Bernese Alps: A Walker's Guide" http://www.amazon.com/bernese-alps-walkers-guide/dp/1852844515. It contains all the information you will need for hiking in the Lauterbrunnental area.

Thank you for reply everyone. Looking forward to our trip next week. Hopefully weather co operates.