You see I learned from being the Dungeon Master, I can play any cool NPC I want. I can be that Arcane Archer or that Dragon Disciple the players dream to become. I can instantly make my NPC as powerful or as weak as I want to. My characters may have the most pwerful or unique magical items at there disposal. My one NPC, Milo Thyretoes was a halfling thief who had my own magical creation known as the "Ring of Changing." Three times a day Milo could change into a small or tiny creature as a free action and change back at will. It added flavor to the game. Also here is a helpful tip to all Dungeon masters wanting to add flavor and or suspense to there dragging game (if there game is indeed dragging) Add what I like to call a Doomed NPC. Have the NPC befriend the party and interact with them. Get the NPC to gain there trust and be great friends untill, all of the sudden a monster does a devasting spell or damage to that NPC causing the players to care and actually feel a lose. Another fun twist is to have an NPC betray the party when they least expect it. In other words play with your players feelings in the game.
Not all dnd games are happy tales.
Furthermore, any dead NPCs should be dead for a REASON. Simply eliminating an important NPC to motivate lax or shallow characters serves the same purpose as stealing their (not 'THERE') most powerful items... it p***es them off. Any important NPC deaths should be significant; heroic, tragic, ordained, or deliberate. An NPC who is martyred becomes a hero to his friends and community. An NPC who gets crushed by an ogre so the PCs will have a reason to smite said ogre is just dead. And, usually, forgotten.
Also, don't discount the use of WEAKER NPCs as plot devices. Say the son of an old NPC is assigned to accompany your PCs on a dangerous mission, as the final test before he is ordained as a Paladin. Now this NPC is a central figure in the quest, but instead of being the uber-hero, he relies on the PCs to keep him alive. This NPC is just as memorable as the Monty Splat Uber Super Magical DM's Favorite Creation Of The Week.
Finally, if your campaign has lagged, there are usually two reasons: (1.) Your PCs have not taken the time to flesh out their (not 'THERE') characters' goals and act upon those goals. (2.) You, as a DM, have not motivated the characters with meaningful goals to pursue.
I can understand that flavourable NPCs add loads to a story, but that I can also read in the DMG. I can't find the exact pages, but I know there are written out examples about NPCs that add to the story, such as the NPC barkeeper, who could (for a mission) have his daughter kidnapped and indeed some NPCs that are rather well worked out and could get a place in your story nearly right away.
I say that you could perhaps expand on this, but the story as you have presented here does not add something in my opinion.
For my own part, I prefer to play an actual character. This means I am subjected to the same rules as the other players, plus a set of metagame restrictions (DM's character doesn't make strategic decisions or take point, etc.). I know that seems inappropriate to many, but it's been common in the gaming circles I've played in, and it has the advantage of giving the DM a character on par with the others that he can identify with and enjoy its progression, etc. while holding that character to the same restrictions as those of the players. Then we keep major NPC interactions for the most part to the role of support or hindrance between encounters. Players occasionally get an uber-ally to help them, but not for more than one or 2 games at a time. The big NPCs stay favor that way, and the DM doesn't end up just playing an unofficial PC several levels ahead of everyone else.
Another point I sympathize with the DM who makes a NPC his own. I'm not condoning this activity I'm simply saying that most DMs wish to play a character. In this case I say you find a DM for your DM so that he can get his fulfillment of being a character and still be a good DM.
Sometimes he'd travel with the PCs, on a flying carpet. Occasionally helping, sometimes throwing an odd fireball...none the less the NPC WAS the campaign, and the PCs loved it (well, the players did, their characters would say something entirely different.) However his role was actually quite small. The PCs accepted a 20 year magical contract with the mage that required the mage to do everything in his power the PCs wanted but the PCs had to help him reach his goal) This allowed the PCs to put as much or as little emphasis on the NPC as they wanted. I liked it. The Players liked it and, remember, you can meet a lot of people traveling!
Interesting NPCs are fine, but overpowered ones steal the show from the players. That is bad.
If the NPCs are overpowered due to items, and my players can defeat him, I can't really argue that they can't keep the cool items. Still, sometimes it just makes sense that someone is more powerful than the players, and they get to feel really good about themselves if they manage to defeat him or her in battle. Especially if afterward I can hand them the NPC sheet and say "Wow, look how overpowered that person is, you did a great job!"
An interesting NPC can truly inspire real world feelings in your PCs regardless if that NPC is a villain or story thread. I am about to run a story in which one of the villains is in charge of a town in which the PCs live. The villain will not directly attack the PCs (at least that is my current intent). I think it will be interesting to see how the players react to a childhood bully/friend is transformed into a villain before their eyes. Will this inspire the PCs to save him or desire to kill him? If they kill him, how will they get away with murder?
Personally, I enjoy creating villains in which the party cannot or should not kill. It creates real world frustration about a problem in which they cannot solve by killing it. It becomes more interesting when the villain (or anti-hero) is not evil, but just dislikes or creates problems for the PCs.
I have used them before. And of course I have used countless NPCs. But the only time I have used a DMPC is when I only had one or two players. While I could have scaled encounters to account for that, I suppose, I found it vastly easier to add a PC-like character to the mix.
But you know what? My DMPCs have always been, and always will be, one level lower than the party's members. They will never be trap finders, nor will they be "faces" (i.e., specialized in interaction skills for in-town encounters, etc). And they will never, EVER outshine the player's characters. Generally, my DMPCs are Clerics or Druids, since those classes are unpopular amongst the players I know, and healing power is always welcome. If I ever need one again, it will probably be a Healer from the Miniatures Handbook.
Now, I would just like to say that I don't believe in having super-powerful NPCs; I don't even believe that NPCs should be as powerful as the PCs. With that being said, I'll get on with my tale.
NPCs are fun for all sorts of plot devices like curses, removing various limbs, psychological torture, and other nasty things that the players wouldn't want their characters going through. I have had several memorably-afflicted NPCs in my games: a half-elf sorcerer that had just earned his wings, only to be found guilty of a crime he didn't commit, and had them ripped out by the roots; a human who, unknowingly, had a bit of fiendish blood in him, and couldn't stay dead until his cruel patron was quite finished with him - he didn't want to be the devil's pawn, but often found himself forced to play the part through various means; his half-celestial older half-brother, who was pulling strings behind the scenes to try and redeem him; and several others that I don't feel like mentioning right now. An afflicted NPC can provide not only motivation for the PCs, because they wish to help him or her, but can also add emotional depth to the game, and really bring out the best (and the worst) in your players.
Unfortunately, most players don't like having any competition at all from NPCs. While the afflicted NPC is fun for a short while, he often outlives his welcome after only a handful of levels. The players begin feeling jealous that, although the NPC may not be as powerful as they, he has a pivotal role in the progression of the game. The feelings of jealousy eventually turn into an outright hatred of the NPC in question, at which point the players start blaming the DM for 'stealing the show' with 'uber-powerful, completely broken' NPCs. When jealousy takes over, players (just as with everybody else) get out-of-hand and begin flinging as many accusations as possible, no matter how absurd.
This is just my take on things. As you can probably tell, I have had very bad experiences with games falling apart over NPCs. On a more personal note, in one campaign my players got so jealous of the plot-pivotal NPC that I lost a good friend in the ensuing fits of impotent anger.
NPCs are a very useful tool, and can add a lot to the game, but user beware: that sword has two edges.
So now I've learned. Any character that travels with the P's can NOT in any way overshadow them. The players are the reason for the story, not the NPCs.