Act I - Twenty-five years previous to the opera, Iolanthe, a fairy, had committed the capital crime of marrying a mortal. The Queen of the Fairies had commuted the death sentence to banishment for life, on condition that Iolanthe leave her husband without explanation and never see him again. Her son, Strephon, has grown up as a shepherd – half fairy, half mortal. Strephon loves Phyllis, a shepherdess who is also a Ward in Chancery. She returns his love, and knows nothing of his mixed origin.
At the beginning of the opera, the Queen is prevailed upon by other Fairies to recall Iolanthe from her exile in a frog bog. Strephon joins the glad reunion and announces his intention of marrying Phyllis in spite of the Lord Chancellor, her guardian, who refuses permission.
Meanwhile the entire House of Lords is enamored of Phyllis. They appeal in a body to ask the Lord Chancellor to give her to whichever Peer she may select. The Lord Chancellor is also suffering the pangs of love, but feels he has no legal right to assign Phyllis to himself. Phyllis declines to marry a Peer; Strephon pleads his cause to the Lord Chancellor again, but in vain. Iolanthe enters and holds tender converse with her son. Since she, like all Fairies, looks like a girl of seventeen, Phyllis and the Peers misinterpret the situation; they ridicule Strephon's claim that Iolanthe is his mother. Phyllis declares that she will now marry either Lord Mountararat or Lord Tolloller. Strephon summons the Fairies to his aid, and the act ends with the Fairies threatening the Peers, and the Peers defying the Fairies.

Act II  - The Fairies take revenge by sending Strephon to Parliament and influencing both Houses to pass any bills he may introduce. His innovations culminate in a bill to throw the Peerage open to competitive examination. The Peers appeal to the Fairies to desist. The Fairies have fallen in love with the Peers and would like to oblige, but it is too late to stop Strephon. The Queen reproaches her subjects for their feminine weakness. She acknowledges her own weakness for a sentry, Private Willis, but asserts that she has it under control.
Lord Mountararat and Lord Tolloller discover that if either loses Phyllis to the other, family tradition requires that they fight unto death; both therefore renounce Phyllis in the name of friendship. The Lord Chancellor, after considerable struggle, pleads his own cause before himself and convinces himself that the law will allow him to marry Phyllis.
Meanwhile Strephon makes Phyllis understand that his mother is a fairy, and they are reconciled. They persuade Iolanthe to appeal to the Lord Chancellor. When he resists her appeal, she reveals her identity to him—her husband—and thus again incurs the death penalty. The other Fairies, however, have married their respective Peers, and announce to the Queen that they all have incurred the same sentence.
The Lord Chancellor suggests a legal expedient which saves the situation. All is resolved happily, and everyone flies off to Fairyland.