The easiest way to get the best quality is to export a refrence file from Final Cut with all the settings the same as your sequence, then open that file with Quick Time Pro and Export as an “iPod Movie.”
That will set everything correctly and do the multiple pass VBR. This will work for sure and it should look great.
If you want to save time on encoding (or get a smaller file) then a single pass with lower settings like you’re doing should work, but I know there are a couple of settings that have to be done right or the iPod won’t accept the file. Here is what Apple’s web site says the iPod plays:
====
H.264 video: up to 768 Kbps, 320 x 240, 30 frames per sec., Baseline Profile up to Level 1.3 with AAC-LC up to 160 Kbps, 48 Khz, stereo audio in .m4v, .mp4 and .mov file formats
MPEG-4 video: up to 2.5 mbps, 480 x 480, 30 frames per sec., Simple Profile with AAC-LC up to 160 Kbps, 48 Khz, stereo audio in .m4v, .mp4 and .mov file formats
===