Investors who are close to retirement are emerging from their storm cellars to assess the damage their retirement portfolios suffered during last year's financial tornados.

A drop of 25% in a 401(k) last year was hardly uncommon, according to the Employee Benefit Research Institute in Washington. Large accounts—those with assets in excess of $200,000—dropped more than 25%. Small and new accounts, however, did not drop as much because the high proportion of new contributions overcame the drag from stock market performance.

While the cleanup job isn't pretty, the good news is that it's possible to rebuild right within a 401(k) plan—and even guarantee some retirement income in the process. The question then becomes: How?

The difficulty in weighing available retirement options-cash out or take a retirement income-is underscored when one looks at a study revised and published in the Journal of Public Economics in 2006. The findings indicated that 25% of those in defined-benefit pension plans would cash out, compared to 95% of those in defined-contribution plans.

Within the 401(k) world, we have to ask ourselves: When we are given a choice, why does feeling rich trump the fear of outliving our lifestyle? People seem to value money in the account much more than a promise of income. However, outliving financial resources is a real possibility. For a healthy 65-year-old couple, there is a 67% chance that at least one of them will live to age 90 and a 38% chance that one will live to age 95.

Most companies today rely solely on the 401(k) as the primary retirement plan for their employees. In an effort to cut down on the chances that someone might outlive their retirement savings, some companies are now offering pension-type benefits within the 401(k) framework, and others are partnering with insurance companies to develop ways to offer guarantees within that framework. These new guarantees are called in-plan annuities because they are annuities sold by insurance companies and offered as investment options inside a 401(k) plan. A guaranteed retirement income builds as the investment option accumulates.

Given these realities, those nearing retirement have to decide what they want so they can take "chance" out of the equation and replace it with "guarantee." Participants have a few options.

For example, they can wait until retirement and buy a fixed payout annuity with a distribution from the 401(k). Many plan sponsors will facilitate this process and make a fixed payout annuity available.

However, the participant takes the risk that the 401(k) account value will decline before the annuity is purchased and the additional risk that annuity benefits decrease if interest rates fall.

The payout is likely quoted on a life-only basis, which means that when the participant dies, the insurance company's obligation to pay monthly income terminates. A popular alternative, which would typically reduce monthly income by less than 10% for a 65-year-old, is to have a life and 20-year period certain payout.

This means that if the participant purchases the annuity at age 65 and dies before the 20 years is up, then the insurance company will continue to pay the beneficiary the monthly income until the participant would have been 85. Of course, in either case the participant will always have income while she is alive.

A second option is to start buying today increments of an in-plan annuity that guarantees income at retirement. This means that every time a transfer or contribution to an in-plan annuity investment option is made the guaranteed retirement income goes up. The timing of these purchases of retirement income is determined by the participant. Since the ultimate retirement income is guaranteed, fluctuations in the account balance and financial markets are less nerve-racking.

The guaranteed retirement income is an option for the participant to exercise at retirement. Depending on the in-plan annuity used, other options may be available at retirement if circumstances change.

Many plans allow for an earlier or later retirement date with a corresponding adjustment of the guaranteed income, though withdrawal of funds prior to exercising the guarantee results in a reduction of the guarantee. Investment allocations and access to the account value after monthly income payments have commenced may be restricted. It is important to understand that features, benefits, charges and limitations of the in-plan annuities are different and will vary based on the issuing insurance company.

Finally, a third option is for the person to personally retain the risk of longevity by keeping full access to account value in place and manage a reasonable withdrawal rate, generally considered 4% to 5%.

By using an advisory service available at many plan sponsors, a reasonable withdrawal rate can be determined based on a participant's risk level and required confidence level.

The best way to compare the three options is to use a specific example and look at the outcomes with different growth assumptions. Results can vary widely based on how you convert the 401(k) balance into income, how you allocate assets, and how the market performs.

Making a mistake can be costly-and it's a mistake that would last a lifetime. Being intentional in planning for retirement income can have big payoffs. With this much at stake, it is important to recognize that the retirement income is dependent on a decision process that should start long before retirement and the sequence of that process is important.

Think about the following to make the process easier:

First, decide whether the certainty of guaranteeing retirement income now is more important than the chance of more at retirement. There is the potential for higher income if 401(k) performance has evolved favorably at the point of retirement.

If certainty is critical, consider contributing to an in-plan annuity today. (In-plan annuities are not available in all 401(k) plans, so be sure to check with the plan sponsor.) Then, at retirement, decide if having longevity protection is essential. If it is, consider exercising the in-plan annuity.