Good news for iPhone users. You can play iPod music as alarm clock sound on your iPhone by using a jailbreak tweak available in Cydia. The name of this tweak is PlayAwake. After you have installed this tweak on your jailbroken iPhone, within the default alarm clock app simply you have to pick a track from the Music Library of your iPhone. Then this tweak will play iPod music as alarm clock sound. PlayAwake fully integrates with clock.app. This tweak is compatible with iPhone running iOS version 4.0 or later.
PlayAwake is available in Cydia under Big Boss repository. It costs $1.99 USD. In order to install this tweak you will need to have a jailbroken iPhone. You can follow the step by step instructions posted here to jailbreak your iPhone on iOS 4.2.1 with Redsn0w. You can watch the video embedded below to see it in action.