At one point the advice was not to insulate gas water heaters. You may now see advice that you should to improve energy efficiency. Insulating can help, but you need to do it correctly.
When I began my home inspection career, I was told that one should never insulate a gas hot water heater by other home inspectors. I noticed that insulation kits for water heaters also had this warning. I wondered though. The concern was that the insulation would come into contact with the gas flame, so the insulation becomes a fire hazard. If the insulation was kept away from possible burning situations, could we insulate? The experts stated that there was no safe way, but ideas changed.
You can insulate your gas water heater if you are careful. My reasoning for doubting the advice had to do with other thinking on appliances that contain fire, especially fire places. In the case of fire places, you have an opening that could allow a flame to spill out. Flammable material can be around a fireplace opening, but the flammable material needs to be kept away from the opening. I thought that the same idea should apply to a gas burning appliance. Many newer gas water heaters have enclosed burner compartments, so the insulation question rises up again: how will the flame come into contact with the insulation? At the time that I noticed more of these water heaters in homes, I saw suggestions that you could insulate gas water heaters, but the instructions were not clear.
In the above photograph, we see insulation on a gas water heater, but there is a problem. If you have a burner compartment which is sealed, you can insulate closer to that opening. If your water heater has a burner compartment that can be accessed by moving plates, you will want to keep the insulation away from this opening. The problem in the photograph is different. I am showing insulation around the vent area, which you do not want to do. Why? There are two reasons: 1) again concern over flammable materials being close to an ignition source; and 2) air flow. The vent at the top of the gas water heater has an opening to allow air to flow into the vent to help with combustion air escape the home. The vent is a tube from the burner compartment going through the water tank. There is a possibility of flames coming through this vent. The other problem is that heat from the vent can cause a flammable material, like insulation, to ignite. For this reason, you want to keep insulation a safe distance from this vent. Another reason is not too obvious, and that is concerning air flow. Some energy efficiency experts studying the problem, have found that insulation could effect air flow, which means that maybe combustion gas is not exiting your home as intended. With both of these reasons, the suggestion is not to insulate the top of your gas water heater.
While we are on the topic of insulation and water heaters, we should touch upon one more idea to save energy. In the second photograph, you see the hot water line. This line consists of the metal line and the red PEX line. You do see some insulation on the line, but it is not on properly. Usually, we like to see the first six feet of the hot water line insulated. My preference (and what I did do in my own home) is to insulate all visible hot water lines. Again, there is the concern of a flammable material being near this top vent, so most installers hold back a bit from placing the insulation to near the opening.
Does insulating help? The greater the insulation keeping the heat in the water heater will help prevent energy loss through the walls of the appliance. There is a point where too much insulation loses its effectiveness. The other factor is maintaining the water heater by draining it every so often to rid the unit of mineral build-up. I do feel that insulating the water heater should be a practice that all should include in their home.