The film opens with Michael, a police informant, finding himself ensnared in a deadly trap created by the Jigsaw Killer. A videotaped message informs him that the death mask, a Venus flytrap-like helmet, has been locked around his neck and will close on his head unless he finds the key in time. Michael realizes, through hints left by Jigsaw, that the key has been implanted behind his right eye. He finds a scalpel nearby, but cannot bring himself to cut out his own eye; when the timer runs out, the device slams shut, killing him instantly.
After an argument with his rebellious teenage son Daniel (Erik Knudsen), Detective Eric Matthews (Donnie Wahlberg) is called to the scene of Michael's death. Following clues that have been specifically left for him, he is able to pinpoint Jigsaw's lair in an abandoned steel factory. The police raid the building and find Jigsaw (Tobin Bell) himself present, though considerably weakened by cancer. Nearby is a set of computer monitors that show eight people trapped in an abandoned house filling with a deadly sarin gas, the same kind as used in the Tokyo subway attacks. Among them are Daniel and Amanda Young (Shawnee Smith), Jigsaw's only known survivor. He reveals that the victims have 2 hours before dying from the nerve agent, but promises that Matthews will see his son in a "safe, secure state" if he can simply talk with the dying man for a while.
The story now intercuts between Jigsaw's lair as Matthews talks with him in an attempt to buy time while the video signal is traced, and the captives in the house, who are trying to secure antidotes to the nerve gas they are breathing. One of them, Gus (Tony Nappo), is killed by a booby-trapped door shortly after they begin their search. Obi (Tim Burd), an accessory to the other victims' kidnappings, is burned alive while attempting to retrieve two antidotes in a furnace. The group later finds a pit filled with thousands of used and bloody hypodermic syringes, with a key to an antidote hidden within. Xavier, the intended victim, throws Amanda into the pit rather than search for the key himself. Amanda retrieves the key, but Xavier fumbles with it and fails to unlock the door to the antidote before its timer runs out.
Meanwhile, Jigsaw explains his evolution into a killer to Matthews and reveals to him that the seven adults trapped in the house are criminals that Matthews has framed. Should Daniel's identity be discovered, he will be in great danger. Matthews, growing impatient with Jigsaw's philosophical ramblings, trashes several models and plans but fails to move Jigsaw.
Xavier, having abandoned the others, realizes that one number of the combination to the safe has been written on the back of each of the victims' necks. After killing Jonas in a fight, he begins stalking the remaining four, who have been made aware that Daniel is the son of the adults' arresting officer. Laura soon dies from gas exposure, and Addison's arms become trapped in a glass box containing razors as she tries to retrieve an antidote for herself.
Matthews, meanwhile, loses control and violently assaults Jigsaw, eventually forcing him to take him to the house at gunpoint. As they depart, the tech team pinpoints the signal, prompting the others to travel to its origin. In the house, Xavier pursues Amanda and Daniel through a hidden basement tunnel, which leads to the bathroom of the first film (including the bodies of Adam Faulkner and Zep Hindle, and the severed foot of Dr. Lawrence Gordon, all now badly decomposed), where Daniel then collapses. Amanda remarks that Xavier has no way of learning his own number, whereupon he slices off a piece of skin from the back of his neck to read it. After he threatens Amanda, Daniel, who has only feigned collapse, fatally slashes Xavier's throat.
SWAT team arrives at the location of the video signal, but it is not the same house that has been shown on the monitors in Jigsaw's lair; these images were previously recorded and are being played back from videotape. Reaching the correct house, Matthews enters the bathroom (now empty except for the bodies) and is injected in the leg with a sedative. At the abandoned lair, a timer expires and a safe opens, revealing a hyperventilating Daniel inside.
Matthews awakens to find himself chained by the ankle to the bathroom's pipework. An audio tape lying next to him reveals that Amanda has put him there. In a montage of flashbacks, she is shown to have become Jigsaw's protégé. Amanda appears in the door and says "Game over," before closing the bathroom door as Matthews screams threats and abuse. Outside the house, a badly beaten Jigsaw slowly forms a smile.
