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Information about Iaito and Shinken

The length measurement is done traditionally in Shaku. This is a 10-based measure that contains Shaku (30.3cm or 11 15/16 inch) Sun (1/10 shaku) and bu (1/10 sun). 

The length is taken as a straight line from the munemachi (the notch on the back where the habaki fits the blade) to the kissaki, the tip. 

The following table was taken from tape measures so don't derive any formula from it! 
 

What size blade should you use?

Good question, some schools are known for longer swords, some for shorter. There isn't any authoritative way of measuring your appropriate sword length that I know of, so my usual advice is to "use the longest blade you can without your technique falling apart". Longer blades tend to look better than shorter (on average) when swung by the same person. Of course it's hard to tell when your technique falls apart. It's also a well known fact that your sword shrinks as you get better at iaido, so what's right for you now may be too short in 5 years. There's also the fact that swords get heavier as they get longer, and a blade may be right for length but wrong for weight. Finally, a tightening shoulder due to age or injury may also necessitate a shorter sword.

Measuring length?

OK another way to measure length is to grasp an iaito loosely in the right hand with a correct grip, drop the arm down naturally to the right side, and see if the tip of the blade clears the floor by an inch or so just around your right little toe.

Or you can use the VERY rough guesstimates given in the table above.

Does it really matter? 

Over my career in sword I've used blades that were from 2.45 to 2.7 shaku long and I still have little trouble adapting to blades from about 2.55 to 2.7 shaku when practicing. To prove the table above inaccurate, I'm 6' 2" tall and my best length is 2.6 shaku for my Muso Jikiden Eishin-ryu iaido practice. I know some folks shorter than I using 2.7 shaku and I know a couple not that much taller than I using 2.8 shaku. 

To repeat, your proper sword length is rather like getting the proper length on your cross country skis, or the length of handle on your tennis racket. There's a lot of factors to consider but in the end, as a beginner it isn't going to matter all that much as long as you get somewhat close to your eventual size. As you get better at the sport you will know if you need a longer or shorter piece of equipment.