Working memory (WM) impairment is a core feature of schizophrenia, but the contributions of different WM components are not yet specified. Here, we investigated the potential role of inefficient encoding in reduced WM performance in patients with schizophrenia (PSZ). Twenty-eight PSZ, 16 patients with bipolar disorder (PBP), 16 unaffected and unmedicated relatives of PSZ (REL), and 29 demographically matched healthy controls (HC) performed a spatial delayed response task with either low or high WM demands. The demands on attentional selection were also manipulated by presenting distractor stimuli during encoding in some of the trials. After each trial, participants rated their level of response confidence. This allowed us to analyze different types of WM responses. WM was severely impaired in PSZ compared to HC; this reduction was mainly due to an increase in the amount of false memory responses (incorrect responses that were given with high confidence) rather than an increase in the amount of incorrect and not-confident responses. Although PBP showed WM impairments, they did not have increased false memory errors. In contrast, reduced WM in REL was also accompanied by an increase in false memory errors. The presentation of distractors led to a decline in WM performance, which was comparable across groups indicating that attentional selection was intact in PSZ. These findings suggest that inefficient WM encoding is responsible for impaired WM in schizophrenia and point to differential mechanisms underlying WM impairments in PSZ and PBP.