Compared to young adults, older adults show not only a reduction in true memories but also an increase in false memories. We investigated the neural bases of these age effects using functional magnetic resonance imaging and a false memory task that resembles the Deese-Roediger-McDermott (DRM) paradigm. Young and older participants were scanned during a word recognition task that included studied words and new words that were strongly associated with studied words (critical lures). During correct recognition of studied words (true memory), older adults showed weaker activity than young adults in the hippocampus but stronger activity than young adults in the retrosplenial cortex. The hippocampal reduction is consistent with age-related deficits in recollection, whereas the retrosplenial increase suggests compensatory recruitment of alternative recollection-related regions. During incorrect recognition of critical lures (false memory), older adults displayed stronger activity than young adults in the left lateral temporal cortex, a region involved in semantic processing and semantic gist. Taken together, the results suggest that older adults' deficits in true memories reflect a decline in recollection processes mediated by the hippocampus, whereas their increased tendency to have false memories reflects their reliance on semantic gist mediated by the lateral temporal cortex.