Is it time to replace my water heater?
The math says that you should replace the water heater - especially if you can install yourself. 

In my opinion the water heater should be sized for the house - how many faucets/bathrooms?, not how many people are currently living in it.  

If you are looking to downsize, save money, be green... I would go tankless.  Here is an example.  Also Tester makes a good point going natural gas.  If you have gas chances are it runs by your current heater so it might be worth looking into.  

Tankless water heater calculator

Sizing a water heater