The film starts off with a man waking up alone, seated in a chair in a grungy, sealed room. A device is secured around his neck. A nearby TV turns on, showing the familiar "clown" figure Jigsaw employed in the first film. Jigsaw's recorded message tells the man that as punishment for being a police informant, spying upon and betraying others, and for not appreciating life, he has to play Jigsaw's "game". When the timer goes off, the device will snap closed, impaling the man's head with several sharp nails lining the inside of the device (like an iron maiden). The TV cuts to the man lying on an operating table with a shadowy figure standing over him, as Jigsaw tells him (and an x-ray photo confirms) that the key to unlock the device has been implanted behind his eye. A scalpel has been left for the man to carve the key out from his eye socket, if he chooses to do so. As he gets up from the chair, he triggers a timer built into the device. The terrified man fails to extract the key in time and is killed.
Detective Matthews is called to the scene, as the deceased was his informant, and discovers a message scrawled on the ceiling which reads, "Look Closer, Detective Matthews." Matthews spots an engraving on the metal contraption, and believes he knows where Jigsaw is - the Wilson Steel building. After his initial reluctance, his former partner, Kerry, finally convinces him to join the team entering the building to arrest Jigsaw.
After some of the accompanying SWAT team fall prey to one of Jigsaw's booby traps, they find Jigsaw. Very ill due to his advanced stage cancer, he offers no further resistance as the SWAT team handcuffs him. As they start to take him away, he directs Matthews and the others to an adjoining room, which contains several monitors showing various rooms of a house, along with an electronic timer counting down from 2 hours. On one of the monitors, Matthews sees a room with eight people forced to play Jigsaw's latest game; among them is Matthews's own son, Daniel. He soon notices that all other seven are people he has framed for crimes they did not commit.
The images on the monitors are not a live feed, but are showing a recording of earlier events. However, by showing those images in parallel with the events filmed by the video cameras, the movie suggests that it is a live video feed. The police also believe this.
The story switches to the captives in the house. Amanda, (a survivor from the original film) breaks through a loose section of a brick wall in the room they found themselves in, and finds a key and a tape recorder containing a taped message from Jigsaw explaining their predicament: they have been exposed to a deadly toxic nerve gas (specifically sarin, which Jigsaw himself references as having been used in the real-life gas attack on the Tokyo Subway) and will die within 2 hours unless they find the antidotes that are hidden around the house (they are given the clue that they all have the combination to the safe in the back of their mind, and that the combination can be found "over the rainbow"). The key has a note warning them not to use it to open the door in the room, but Xavier ignores the message, and turns the key in the lock while Gus looks through the eyehole. The lock is rigged to fire a gun pointing directly at the eyehole. The gun discharges into Gus's eye, killing him. Amanda reveals to the others that she has had to play one of Jigsaw's games before, and pleads with them that they have to follow his "rules".
The terrified captives begin to explore the house. Laura finds another door which leads to the basement, with another tape marked for Obi which reveals how he had assisted Jigsaw to get the others in the house and explaining that there are two antidote syringes inside a large furnace in the room. Obi climbs inside to retrieve them, the door closes and the furnace ignites. Obi is burned to death before they can get him out, and both antidotes are lost.
The Jigsaw killer insists that Matthews has to play a game to save his son. The game is simple, he just has to sit with Jigsaw--by himself--and listen to what he has to say. All the while, the timer is ticking away in the room with the monitors. Matthews is on the verge of cracking, but decided he has no other choice but to hear Jigsaw out. Through a series of flashbacks, Jigsaw is revealed to be a terminal cancer patient, who attempted suicide by driving his car of a cliff. However, Jigsaw survived the suicide attempt, despite severe injuries. Henceforth, Jigsaw resolved to test the human ability to overcome great suffering in order to save his or her life.
Forcing open a door into another room, the captives find another tape, this one marked for Xavier. On the tape, Jigsaw condemns him for his life as a drug pusher and states that if he wants to escape, he must wallow in the filth that he made others wallow in. Daniel pulls back a sheet to reveal a pit full of syringes. The message says a key is in the pit that will open a door concealing another antidote. Xavier grabs Amanda and throws her into the pit, yelling at her to dig through them to find the key. Stabbed with dozens of needles, Amanda finally finds it and gives it to Xavier. He races to the lock but fumbles with it. The door's timer expires, sealing the door forever. Daniel helps Amanda out of the pit.
After growing tired of listening to Jigsaw and helplessly watching one captive after another die while the timer runs down, Matthews finally snaps and unleashes his rage on the old man. Savagely beaten and battered by Matthews, Jigsaw utters his "Game over," catchphrase and finally agrees to take Matthews to the house, but only if he can take him alone.
In the house, for the movie audience seemingly meanwhile, Xavier has snapped and is trying the kill his fellow captives to retrieve the different colored numbers written on the back of their necks (the answer to Jigsaw's cryptic clue "You all possess the combination. It's in the back of all your minds.". The different colors represent colors of the rainbow and putting them in the order of the rainbow will unlock the safe). These numbers are supposed to be the combination to the safe in the first room which holds an antidote. He kills Jonas by hitting his head with a club with large nails sticking out, and then goes after the others.
Addison finds a picture concealing a photo of Daniel and Matthews together, marked "Father and son"; this may make the others hate Daniel for being the son of the cop who framed them all. The effects of the toxin are starting to become more severe, and Laura succumbs to the nerve gas. Amanda finds Jonas's body and realizes Xavier means to kill them all. She goes back to rescue Daniel.
While pursuing Amanda and Daniel, Xavier comes across Addison who has fallen victim to another of Jigsaw's contraptions - a glass box suspended from the ceiling that contains an antidote. On the underside of the box are two holes just wide enough to put one's arms through, once pushed past the blades covering them. She discovers too late that the blades are arranged similar to a Chinese finger trap, preventing her from removing her arms once inside; the edges dig deeper into her flesh the harder she pulls. Xavier reads her number and leaves her to die in the contraption.
Without telling his team, Matthews leaves with Jigsaw in his van. Almost immediately after this, the police finally locate the broadcast location of the video feed and take off for that location. Jigsaw shows Matthews the house in which the events has taken place. Jigsaw gives Matthews the key to get inside. Matthews gets inside, still believing that the video images were live. He finds the dead bodies of the victims littered throughout the rooms.
Amanda and Daniel retreat to the first room as Xavier tries breaking through the door to get at them. Amanda pushes aside the safe, revealing a trap door underneath. They go through the hatch just as Xavier breaks through. He follows them, cornering them in the infamous bathroom from the first movie. The bodies of Adam and Zep, and Dr. Lawrence Gordon's severed foot are still there, in a state of advanced decay and covered with fungus and mold. Amanda tells Xavier that Daniel is dead and that if he kills her, he won't be able to find out the number on his own neck. Xavier, now insane from the poison, takes his knife and slices a section of skin off the back of his neck. He moves in to kill Amanda, Daniel suddenly jumps forward, crushing Xavier's ankle and, using the hacksaw from the first movie, slits Xavier's throat, killing him.
While the SWAT team enters what they and Kerry assume to be the same house, Kerry is watching the monitors, confused that the cameras aren't showing them in the house. For Kerry and the movie audience it turns out that, as mentioned above, the images on the monitors, shown in the movie in parallel with the events filmed by the video cameras, were not a live feed, but were showing a recording of earlier events, and that the broadcast location where the SWAT team has arrived is not the location where the events have taken place. We now know how Jigsaw was able to say 'I haven't looked at the monitors for a while but I assume [Daniel] is still sitting in a corner...'.
Meanwhile Detective Matthews enters through a back door, finds the open trapdoor and goes down to search for Daniel. A shot of a syringe here explains how Daniel has survived the exposure to gas. Matthews gets into the darkened bathroom, and sees someone lying in the bathtub. He approaches cautiously, but the person inside, wearing the same animal mask from the first film, leaps up and stabs him in the leg with a syringe. Matthews drops to the floor. The attacker removes the mask, it is Amanda.
The timer in the room at Wilson Steel expires and a safe across the room opens to reveal Daniel, wearing an oxygen mask, weary but alive. He had been there already when the SWAT team came into the building and found Jigsaw, two hours earlier; had Matthews followed the rules to Jigsaw's "game", he would have found his son "in a safe, secure place" just as Jigsaw had told him.
When Matthews wakes up, he finds an audio cassette player lying next to him. Playing the tape, Matthews learns that Amanda has become Jigsaw's protege and has now taken his place. In a series of flashbacks we understand why Jigsaw was happy to sit back while Matthews tore his work up and see that Amanda was the one who brought Daniel back to be placed in the safe. Matthews then watches helplessly as Amanda closes the door on him. "Game over," she says, iterating Jigsaw's catchphrase. Matthews, chained to a pipe, is left in the room alone only with the light from his flashlight and his gun now just out of reach. Jigsaw is shown, still sitting in Matthew's van, badly beaten but smiling.
