You can reduce the heat loss from your water heater by installing an exterior blanket of fiberglass insulation. This is one of the most common and effective water-heating energy-conservation measures available. Most older water heaters have only an inch of fiberglass, and most newer ones have an inch of foam insulation. Neither of these insulation levels is adequate for minimizing heat loss.
Water-heater blankets come in kits, which also contain straps and/or tape to hold the blanket on. The straps hold the insulation to the water heater, and the tape seals the vertical seam in the insulation. With electric water heaters, you may insulate the top of the tank. With gas water heaters, don’t insulate the top. With electric water heaters, note where two rectangular covers provide access to the thermostats and elements, one near the top and one near the bottom on the side of the tank. Cut little trap doors in the insulation to provide access to these panels. On gas water heaters leave two inches of clearance between the insulation and the gas valve and burner access door.
With electric water heaters, you insulate the tank’s top. With gas you insulate only the sides.
The Homeowners Handbook to Energy Efficiency contains simple, practical energy-efficiency ideas.