Lara made 18 in West Indies' 300 all out before his bowlers and fielders raised hopes of a win.
However, Kevin Pietersen's hundred and Paul Nixon's gritty 38 spoiled the genius's farewell at the Kensignton Oval.
A capacity crowd stood up and cheered Lara who shook hands with all his teammates before umpire Rudi Koertzen bid farewell to the batting great.
Rival captain Michael Vaughan came onto the ground, followed by other members of the England team to give Lara their own send-off.
Lara wiped away the tears, waved at the 22,500-crowd before leaving for the pavilion.
"I thank you all, some of my school friends were here and some of my greatest fans. I enjoyed every minute of it and it was unfortunate that we did not win," said Lara.
"I had always dreamed of seeing the West Indies on top of the world, sadly this was not achieved but whoever takes over from me I hope he gets the full support."
Earlier the maestro fell short of his desired last big innings.
Playing his 299th and last one-day match, Lara was sent back by Marlon Samuels on the fifth ball of the 31st over bowled by Stuart Broad.
But the master batsman, at the non-striker's end, failed to beat a rolling throw from Kevin Pietersen from mid-on and was well short of his crease.
The 37-year-old left-hander trudged back, shaking his head in disappointment, removed his helmet and turned back to raise his bat for the last time to a huge standing ovation by the capacity 23,000 crowd.
He dropped his glove, before he picked it up and waved his bat to the stands.
It was his last walk to the Sir Gary Sobers pavilion - the famous quick steps into the dressing room where all his team-mates stood up and applauded.
"It was a historic occasion," said former West Indies captain Jimmy Adams who played with Lara at the 1996 and 1999 World Cups.
"He had a wonderful reception. It was all set for him. He looked to be setting himself up with a trademark cover drive and a couple off the legs.
"He was looking good but then it all went wrong."
Lara had to wait for 23.5 overs to walk to the middle as Chris Gayle (79) and Devon Smith (61) put on a brilliant 131 for the opening wicket.
When Lara stepped out for his last innings Gayle embraced him, and a loud cheer and standing ovation accompanied him to the middle as fans, who had started to arrive at the ground since early morning, paid a deserving farewell to the batting legend.
All the England players formed a guard of honour for the West Indies skipper.
First ball, Lara played a defensive stroke off England paceman Flintoff and in the next James Anderson over he opened his account with a single to cover.
He went down the pitch to congratulate Smith for his half-century, before being beaten by an Anderson delivery.
He took another single in the next over and then went back to hit Flintoff to the covers for his first boundary.
It was a typical Lara cut on the up, a shot which has enthralled crowds all over the world throughout his 17-year international career.
In the next over, a deft flick off Anderson brought Lara his second boundary and once Smith fell, Lara walked down to direct Samuels.
Flintoff came close to dismissing him when Lara tried to guide the ball through the slips with a diving Andrew Strauss just failing to reach the ball.
However, his 17-ball innings came to a disappointing end with the run out.
It was the 19th time he had been run out in his one-day career but perhaps, befittingly, no bowler could clain the great man's scalp in his last outing.