We have a conversation about it, and talk about how we could make some of them. We also don't look at web sites or go through costume sections until we've decided on something. Every year, DD sees a made costume that she says she wants for the next year (usually character she likes at the time) but forgets it by next year when she's not into that character. I don't make costumes from scratch, but I usually use a sweatsuit and add embellishments and hats from there. She hates violent stuff, so that's never been a concern. Generally I work from the perspective of how we can make something and have it be reasonable cost and effort. She doesn't have adult standards though, and I think that's fine if she's happy with the costume.
She's been baby Elvis (for a costume wedding, DH and I went as "Mr. and Mrs. Presley" in just generic clothes for the period), a parrot (as "bird" was one of her favorite animals and words. Those she didn't really choose, she was too young. She's also been "Lucky" from the "101 Dalmations book," and she studied the book pictures to get the right collar color, if he had black or white ears, and on which side, etc. She likes us to be a theme, so that year I was informed that I had to be Anita Darling.
She was a dolphin, which was fun to make (I was a "dolphin trainer" and fed her goldfish crackers for doing tricks). And she was a butterfly last year. DS was nothing his first year, as he was a few weeks old. Then he was a caterpillar last year (I was a butterfly too, and DH was a "Butterfly scientist" with a net and paper butterflies per DDs idea).
This year DD is going to be the tooth fairy (wearing her fairy costume, along with a headband we're making out of quarters, a bracelet from a melted toothbrush, a wand with a dowel, poster board tooth, and glitter, and plastic teeth on a necklace). I'll be a tooth with a sandwich board style tooth made from poster board.
DS is a parrot (reusing from DDs costume at age 2- shirt with felt wings sewn on, hat with beak and button eyes sewn on, felt skirt with velcro worn over pants). DH is a pirate with hat and eye patch.