On Christmas Eve 1945, in Bedford Falls, New York, George Bailey contemplates suicide. The prayers of his family and friends reach heaven, where Clarence Odbody, Angel 2nd class, is assigned to save George, in return for which he will earn his angel wings. To prepare him for his mission, Clarence is shown flashbacks of George's life. The first is from 1919, when 12-year-old George saves his younger brother Harry from drowning in a frozen lake; George loses his hearing in one ear as a result. At his after-school job, George realizes that the druggist, Mr. Gower, distraught over his son's death from flu, has accidentally added poison to a child's prescription, and intervenes to stop him from causing harm.
In 1928, George plans to leave on a world tour and then attend college. At Harry's high-school graduation party, George is reintroduced to Mary Hatch, who has had a crush on him from childhood. Their walk home is interrupted by news that George's father, Peter, has died of a stroke. George postpones his travel so he can sort out the family business, Bailey Brothers' Building and Loan. Henry F. Potter, the richest and meanest man in town, wishes to dissolve the Building and Loan to eliminate it as a competitor. The board of directors votes to keep the Building and Loan open, on condition that George stay to run it (along with his absent-minded uncle Billy). George gives his college tuition to Harry on the condition that Harry take over the Building and Loan when he graduates.
Four years later, in 1932, Harry returns from college married and with a job offer from his father-in-law. Although Harry is ready to honor his commitments to George and the Building and Loan, George learns that the job has excellent prospects and will not allow his brother to turn it down. As a result, George never does leave Bedford Falls, but ends up falling in love with Mary and they marry. On their way to their honeymoon, though, they witness a run on the bank and use their $2,000 honeymoon savings (equivalent to $39,000 in 2018) to keep the Building and Loan solvent and out of Potter's control until the panic subsides.
Eventually, George establishes Bailey Park, a development of modest houses financed by the Building and Loan that offers home ownership in contrast to rentals in Potter's overpriced slums. The unscrupulous Potter attempts to lure George into becoming his assistant, offering him $20,000 a year (equivalent to $280,000 in 2018); George is momentarily tempted, but realizes Potter's true intent is to shut down the Building and Loan, and rebukes him.
During World War II, George is ineligible for service because of his deaf ear. Harry becomes a Navy pilot and earns the Medal of Honor by shooting down a kamikaze plane headed for a troop transport. On Christmas Eve morning 1945, as the town prepares a hero's welcome for Harry, Uncle Billy goes to the bank to deposit $8,000 (equivalent to $110,000 in 2018) of the Building and Loan's cash. When Potter enters, Billy taunts him by grabbing the newspaper out of his lap and reading the headline about Harry aloud. Billy returns the newspaper to Potter, but unintentionally wraps the envelope with the cash in it. When the teller asks him for the money for the deposit, Billy discovers that he has misplaced the cash. Potter discovers the envelope, and seeing an opportunity to ruin the Baileys and finally quash the Building and Loan, says nothing. When a bank examiner arrives to review the Building and Loan's records, George realizes that scandal and criminal charges will follow. After retracing Billy's steps without success, George berates him, then goes home and takes out his frustration on his family.
George desperately appeals to Potter for a loan and offers his life insurance policy with only $500 in equity (equivalent to $10,000 in 2018) as collateral. Based on the policy's $15,000 nominal value, Potter says that George is worth more dead than alive and phones the police to have him arrested. George gets drunk at a local bar and prays for help, then, contemplating suicide, goes to a nearby bridge. Before George can jump, Clarence dives into the river, causing George to rescue Clarence rather than kill himself. George does not believe Clarence's subsequent claim that he is George's guardian angel.
When George says he wishes he had never been born, Clarence decides to grant his wish to show George an alternate timeline in which he never existed. Bedford Falls is named Pottersville and is dark and corrupt. Mr. Gower, the druggist, has recently been released from prison for manslaughter, because George was not there to stop him from putting poison in the pills. The Building and Loan has long since closed down, as George never took over after his father's passing. George's mother does not know him; she reveals that Uncle Billy was institutionalized after the Building and Loan failed. In the cemetery where Bailey Park would have been, George discovers Harry's grave; Clarence explains that the soldiers on the transport ship died because Harry was not there to save them, since George was not alive to save Harry from drowning. When George seeks out Mary, who never married, and claims he is her husband, she screams for the police. George flees and the local policeman gives chase.
Now convinced that Clarence is really his guardian angel, George now grateful having imagined and experienced what his life is like without the things he has, runs to the bridge and begs for his life back; the alternate timeline changes back to the original reality. George being grateful with his life back rushes home to await his arrest. Mary and Uncle Billy arrive, having rallied the townspeople, who stream in and donate more than enough to cover the missing $8,000 causing the town sheriff to rip up an arrest warrant for George. Harry arrives and toasts George as "the richest man in town". A bell on the Christmas tree rings, and the youngest daughter, Zuzu, says that the sound means that an angel has just earned his wings, signifying Clarence's promotion.
