Angela Darling works as a waitress at Darling’s Diner near a railroad in the rural South, with her young children – twins James and Douglas, and youngest daughter Wendy – hanging around there. Youngster Thomas Marshall, having his birthday one day, is jokingly told by his grandmother that he and Angela’s children that they’ll be working at the diner when they grow up. Insisting that he’ll be a pirate, Thomas goes outside at the thought of having to get older and work. A train passes by, and a small figure runs on the roof and gets Thomas to climb onto the train as Wendy watches.
Years later, Wendy is nine years old and has a thirst for adventure, coming up with her own bedtime stories to read to herself, despite assisting her mother with the diner along with her brothers. One night, Angela tells them about her life, indicating that she gave up on her dreams to raise a family, making Wendy wonder whether she will have to give up her own dreams as a grown-up. After school, Wendy contemplates boarding the train, but fails to do so when she chases it.
That night, Wendy notices a boy at her window, who jumps onto the train and inspires her to follow. Waking her brothers, the kids climb out of their window and hop onto the train. They are met by the boy, rambunctious Peter, who tells them they are going on an adventure. Travelling through the night, the kids ride the train far away from home until Peter pushes them out into a river. There they encounter another kid, Cudjoe Head, in a rowboat, which takes them all to a volcanic tropical island where they find other children, including Thomas, who is still as young as he was when he ran away.
The Darlings discover that children have a connection with the island’s spirit from the volcano, called Mother by Peter, who tells Wendy that as long as they believe in Mother she will provide for them. Mother’s influence prevents the children from aging, so long as they believe in her, explaining how Thomas remained a child. Peter takes Wendy and her brothers across the island, playing with the other boys and having many adventures; as well as discovering Mother’s physical form as a large glowing fish and that singing to her revitalises her. Despite the island’s paradise, Wendy starts to worry for her mother and the fact that she will notice her children are gone.
While the kids are sleeping, an elderly man wanders close by. When Wendy greets him, he runs off into a barren side of the island, where the other children shun him. They explain his name is Buzzo, a former member of their group who lost faith in Mother when he lost his best friend, and so aged into an old man. Whilst exploring, the children find a capsized boat called the Mañana, which the Darlings swim into. Douglas hits and cuts his head, disappearing from sight. Wendy and James get Peter and the other children to help look for him, but after searching the island they find it a lost cause. Without his twin brother, James becomes more withdrawn and dour.
Wendy discovers that James’ right hand has become aged, and although he and Wendy try to hide it, Peter soon notices it. Fearing it’ll mean he will age rapidly like Buzzo, he asks Peter to cut it off, who does so with his knife. Shocked and disgusted, Wendy takes James to the outskirts, where she finds Buzzo. He takes them to the other side of the island, where a group of “Olds”, children who lost faith in Mother, live a sullen and depressed life. Wendy’s attempts to cheer them up fail when James, bitter at having to grow up without Douglas, rallies the group to find, kill and eat Mother in order to regain their youth, using the children as bait.
Wendy runs back to warn them, but is too late when the Olds show up and kidnap the children, and repurpose the Mañana as a fishing boat. Evading the Olds, Wendy and Peter witness an older James fashioning a hook for his missing hand. Whilst hiding from the Mañana, the pair discover that Douglas is alive. They swim to the Mañana, where they find the now elderly James, who shows resentment towards Douglas for not aging as he did. The ship approaches the Mother fish, which James throws a harpoon at and severely wounds it. After Peter and Wendy rescue them, the children go underwater to help Mother, but she dies and James finds a piece of Mother losing its glow. With Peter and the children mournful and the Olds disheartened, Wendy gets them to all start singing. As their singing grows louder, Peter becomes more inspired, and the volcano erupts once more. Wendy and Douglas decide it is time for them to go home. Knowing that he cannot go home, James stays to play with Peter as his new “enemy” Captain Hook, thereby allowing him to live out the rest of his days with the spirit of a child.
In Wendy’s closing narration, she, Douglas and the other children have returned home to their own families. They have many adventures together as they grow older, eventually growing apart. Many years later, Wendy is now a mother with her own daughter, telling the story of Peter and the island. At night, while Wendy sleeps, her daughter hops on the train with Peter. Wendy sees and runs after them, but she cannot catch up to them. Wendy then decides not to pursue, as she feels her daughter is in good hands and is ready for an adventure of her own.