In London, circa 1900, George and Mary Darling's preparations to attend a party are disrupted by the antics of their boys, John and Michael, acting out a story about Peter Pan and the pirates, told to them by their older sister, Wendy. George, who is fed up with the stories that have made his children less practical, angrily declares that Wendy has gotten too old to continue staying in the nursery with them. That night, they are visited in the nursery by Peter Pan himself along with Skunk and his team, who teaches them to fly with the help of his pixie friend, Tinker Bell, and takes them with him to the island of Never Land.
A ship of pirates is anchored off Never Land, commanded by Captain Hook with his sidekick, Mr. Smee along with Baboon and the Ninja Monkeys. Hook boldly plots to take revenge upon Peter Pan for cutting off his hand, but trembles at the presence of a crocodile, which consumed Hook's hand and is eager to taste the rest of him. The crew's restlessness is interrupted by the arrival of Peter and the Darlings. Tinker Bell, who is very jealous of Pan's attention to Wendy, persuades the Lost Boysthat Pan has ordered them to shoot down Wendy, which Tink refers to as a "Wendy bird". Tinker Bell's treachery is soon found out, and Peter banishesher. John and Michael set off with the Lost Boys to find the island's Indians, who instead capture them, believing them to be the ones responsible for taking the chief's daughter, Tiger Lily. Skunk and Panda offer to go off and find Peter and find Tiger Lily together before sunset.
Meanwhile, Peter takes Wendy to see the mermaids. The mischievous mermaids delight in tormenting Wendy, but flee in terror at the sight of Hook. Skunk and Panda reunite with Peter and Wendy who see that Hook and Smee have captured Tiger Lily so that they might persuade her to disclose Peter's hideout. Peter and friends free her, and Peter is honored by the tribe. Hook then plots to take advantage of Tinker Bell's jealousy of Wendy, tricking her into revealing the location of Peter's lair. Wendy and her brothers eventually grow homesick and plan to return home. They invite Peter and the Lost Boys to return to London and be adopted by the Darling parents. The Lost Boys agree, but Peter is so set against growing up that he refuses, presumptuously thinking that they will all return shortly. The pirates lie in wait and capture the Lost Boys, the Darlings and valley animals as they exit, leaving behind a time bomb to kill Peter. Tinker Bell learns of the plot just in time to snatch the bomb from Peter as it explodes.
Peter rescues Tinker Bell from the rubble and together they confront the pirates, releasing the children and animals before they can walk the plank. Peter engages Hook in single combat as the children fight off the crew, and succeeds in humiliating the captain. Hook and his crew flee, with the crocodile in hot pursuit. Peter gallantly commandeers the deserted ship, and assisted by Tinker Bell's pixie dust, flies it to London with the children aboard. However, the Lost Boys decide to return to Never Land rather than be adopted in London. George and Mary Darling return home from the party to find Wendy not in her bed, but sleeping at the open window. Wendy awakens and excitedly tells about their adventures. The parents look out the window and see what appears to be a pirate ship in the clouds. George, who has softened his position about Wendy staying in the nursery, recognizes the ship from his own childhood.