Another problem is that the most common method retirees use to draw down their retirement savings is to simply withdraw what they think they need to meet their living expenses. Most retirees don't have a formal plan to generate reliable lifetime retirement income. 

A recent survey from Wells Fargo titled "Middle Class Americans Teeter on Edge of Retirement Cliff" provides additional insights into the challenge of making your money last throughout your retirement. When asked how much of their retirement savings they could annually withdraw during retirement, the respondents' median answer was 10 percent.

But if retirees actually withdraw from their savings at this rate, the odds are overwhelmingly high that they'll experience "money death" before actual death. In fact, according to a recent blog post by retirement expert Dr. Wade Pfau, there's a very good chance that a withdrawal rate of 10 percent will result in a retirement savings that's exhausted in 10 to 20 years – well short of the expected average lifetime of people currently in their mid-60s.

Next: Setting up retirement income generators

As a result of these issues, retirees relying on their 401(k) accounts to provide significant retirement income face the risk of outliving their financial resources, possibly impoverishing themselves in their later years.

Fortunately, there is a solution. Instead of spending haphazardly, retirees should consider their retirement savings to be a monthly retirement income generator, or RIG for short. Then they should spend no more than the amount of the money their savings can generate each month – in other words, their "retirement paycheck."

Since most people already live paycheck to paycheck during their working lives, adhering to this financial discipline when they retire shouldn't be too hard. If retirees plan out their spending in retirement, there's a good chance they won't go broke. 

There are essentially only three ways to generate a monthly paycheck from retirement savings: 

• RIG #1: Invest the savings, and spend just the investment earnings, which typically consists of interest and dividends. Don't touch the principal.
• RIG #2: Invest the savings, and draw down the principal cautiously so as not to outlive their assets. This method is called "systematic withdrawals."
• RIG #3: Buy an immediate annuity from an insurance company, and live off the monthly benefit the insurance company pays to the retiree. 

These RIGS each have their advantages and disadvantages; there's not one magic bullet that works best for everybody. Most important, each type of RIG generates a different amount of retirement income:

• RIG #1, interest and dividends, typically pays an annual income ranging from 2 percent to 3.5 percent of savings, depending on the specific investments selected and the allocation between stocks, bonds, cash, and real estate investments.
• RIG #2, systematic withdrawals, typically pays an annual income that ranges from 3.5 percent to 5 percent of savings, depending on the specific investments, the age of the retiree, and how cautious retirees are about the odds of exhausting their savings before they die.
• RIG #3, immediate annuities, can range from 4 percent to 6.5 percent of savings, depending on the type of annuity that's purchased, the retiree's age and sex, and whether the annuity income is continued to a beneficiary after the retiree's death. 

Next: How can plan sponsors help?

But retirees don't need to use just one type of RIG to generate retirement income from savings. In fact, it might be best to use a combination of a few different types. Some financial institutions have even been introducing hybrid products and solutions that combine features of two or more of these basic RIGs. In addition, there can be good reasons to change the RIGs as retirees get older. 

How can plan sponsors help? Employers could add payout options in their 401(k) plan to generate retirement income. Better yet, they could adopt a retirement income menu that's analogous to the investment menus that are already available in most 401(k) plans. A retirement income menu could offer a handful of distinct RIGs, including systematic withdrawals, annuities, or some combination of the two.

Because these methods of generating retirement income all meet different goals and objectives – and because there's not one method that meets the needs of all retirees – the menu could be accompanied by a robust communications campaign regarding the pros and cons of each method.

With the investment menu that's common in 401(k) plans, employers shop for the investment options that are offered to their employees and negotiate the best deal on behalf of their employees, minimizing fees and allowing employees to get institutional pricing instead of retail pricing. Why not do the same for payout options?

With a retirement income menu, the employer is the entity that's looking out for the best outcomes for its employees, with no financial stake in the decisions made by employees. By contrast, the advisors retirees may have to consult have a stake in the decisions made by their clients, through the fees or commissions the advisors receive.

A retirement income menu would build on recent innovations and evolutions in 401(k) plans, such as the use of target date funds, auto-enrollment, and auto-escalate features, all of which are intended to improve the retirement security of employees. While there are important business reasons why an employer would implement a retirement income menu, the most compelling reason might be that it's just the right thing to do for older workers.

Steve Vernon, FSA, is the author of Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck. He is the president of Rest-of-Life Communications and has more than 35 years of experience as a consulting actuary, helping Fortune 1000 companies design and manage their retirement programs. He can be reached directly at [email protected].