Lesion studies have shown convincingly that the medial temporal lobes (MTL) and frontal lobes are critical to episodic memory. Ageing generally has been found to have a generally negative effect on episodic memory performance, which might relate to neurofunctional changes in the frontal and medial temporal brain regions. In the present study, we used functional MRI (fMRI) to investigate separately the contributions of encoding and retrieval to the age‐related decline in memory. To this end, we compared brain activity patterns obtained during incidental encoding (pleasant/unpleasant judgements about nouns) and subsequent retrieval (recognition) in three groups: a group of young subjects, a group of elderly subjects showing reduced memory performance (ELD‐RED), and a group of elderly subjects who still performed in the normal range (ELD‐NORM). This allowed us to differentiate between age‐related changes in brain activity that affect memory function and those that do not have an apparent effect on memory function, because they are found in both elderly groups. Contrary to previous imaging studies on this topic, we used (self‐paced) event‐related fMRI to control for differences in performance level across groups by including correct responses only. Comparing the encoding of successfully remembered items with baseline (press left/press right), the young subjects showed a significant increase in brain activation in the left anterior MTL compared with the ELD‐RED but not the ELD‐NORM subjects. Comparing correctly rejected items (retrieval attempt) with baseline, the ELD‐RED group showed much increased overall activity throughout the brain compared with the other groups. However, when correctly recognized items (retrieval attempt + success) were com pared directly with correctly rejected items (retrieval attempt), these differences were greatly reduced, revealing common activity in the left parietal, retrosplenial and left anterior prefrontal regions. Therefore, we conclude that the reduced performance in the ELD‐RED group is likely to be due to MTL dysfunction during encoding. The differences observed during retrieval attempts may reflect strategic differences. The lack of differences observed in relation to retrieval success suggests that ageing does not affect the processes that support the actual recovery of information.