On Christmas Eve 1945, in Bedford Falls, New York, George Bailey contemplates suicide. The prayers of his family and friends reach Heaven, where guardian angelsecond class Clarence Odbody is assigned to save George in order to earn his wings. Clarence is shown flashbacks of George's life. He watches 12-year-old George rescue his younger brother Harry from drowning, leaving George deaf in his left ear. George later prevents the pharmacist, Mr. Gower, from accidentally poisoning a customer's prescription.

In 1928, George plans a world tour before college. He is reintroduced to Mary Hatch, who has been enamored with him since childhood. When his father dies suddenly, George postpones his travel to settle the family business, Bailey Brothers Building and Loan. Avaricious board member Henry Potter, who controls most of the town, seeks to dissolve it, but the board votes to keep the Building and Loan open if George runs it. George acquiesces and works alongside his uncle Billy, giving his tuition to Harry with the understanding that Harry will run the business when he graduates.

Harry returns from college married and with a job offer from his father-in-law, and George resigns himself to running the Building and Loan. George and Mary rekindle their relationship and wed. They witness a run on the bank and use their honeymoon savings to keep the Building and Loan solvent. Under George, the company establishes Bailey Park, a housing development surpassing Potter's overpriced slums. Potter entices George with a $20,000/year job but, realizing that Potter's true intention is to close the Building and Loan, George rebuffs him.

On Christmas Eve 1945, the town prepares a hero's welcome for Harry who, as a U.S. Navy fighter pilot, was awarded the Medal of Honor for preventing a kamikazeattack on a troop transport. Billy goes to Potter's bank to deposit $8,000 of the Building and Loan's money. He taunts Potter with a newspaper headline about Harry, then absentmindedly wraps the cash in Potter's newspaper. Potter finds and keeps the money, while Billy cannot recall how he misplaced it. With a bank examiner reviewing the company's records, George realizes scandal and criminal charges will follow. Fruitlessly retracing Billy's steps, George berates him and takes out his frustration on Mary and their children. George appeals to Potter for a loan, offering his life insurance policy as collateral. Potter scoffs that George is worth more dead than alive, refuses to help, and phones the police.

George flees Potter's office, gets drunk at a bar, and prays for help. Suicidal, he goes to a nearby bridge, but before he can jump, Clarence dives into the river and George rescues him. When George wishes he had never been born, Clarence shows George a timeline in which he never existed. Bedford Falls is now Pottersville, an unsavory town occupied by sleazy entertainment venues, crime, and callous people. Mr. Gower was imprisoned for manslaughter because George was not there to stop him from poisoning the customer. George's mother does not know him. Uncle Billy was institutionalized after the Building and Loan failed. Bailey Park is a cemetery, where George discovers Harry's grave. Without George, Harry drowned as a child, and without Harry to save them, the troops aboard the transport ship were killed. George finds Mary, now a spinster, and when he grabs her and claims to be her husband she screams and runs. 

George flees back to the bridge and begs Clarence for his life back. The original reality is restored, and a grateful George rushes home to await his arrest. Meanwhile, Mary and Billy have rallied the townspeople, who come into the Bailey home and donate more than enough to cover the missing money. Harry arrives and toastsGeorge as "the richest man in town". Among the donations George finds a copy of The Adventures of Tom Sawyer, a gift from Clarence and inscribed, "Remember, no man is a failure who has friends. Thanks for the wings!" When a bell on the Christmas tree rings, George's youngest daughter, Zuzu, explains that "every time a bell rings, an angel gets his wings." George looks upward smiling and says, "Atta boy, Clarence!"