The West Berlin office of the Circus is under the command of Station Head Alec Leamas, who served as an SOE operative during World War II and fought in the Nazi-occupied Netherlands and Norway. It has just lost its last and best double agent, shot while defecting from East Berlin. With no operatives left, Leamas is recalled to London by Control, the Circus chief, who asks him to stay 'in the cold' for one last mission: to fake the defection of a senior British agent to an East German operative named Mundt, and then to frame Mundt as a British double agent. Fiedler, one of Mundt's subordinates — who already suspect that Mundt is a double agent — is targeted as a potentially useful adjunct.
To bring Leamas to the East Germans' attention as a potential defector, the Circus sacks him, leaving him with only a small pension. He takes and loses a miserable job in a run-down library. There, he meets Liz Gold, who is the secretary of her local Communist Party cell, and they become lovers. Before taking the final plunge into Control's scheme, Leamas makes Liz promise not to look for him, no matter what she hears. Then, after getting Control to agree to leave Liz alone, Leamas initiates the mission by assaulting a local grocer in order to get himself arrested.
After his release from jail, he is approached by an East German recruiter and taken abroad, first to the Netherlands and then to East Germany, en route meeting progressively higher echelons of the Abteilung, the East German intelligence service. During his debriefing, he drops casual hints about British payments to a double agent in the Abteilung. Meanwhile, Smiley, posing as a friend of Leamas, appears at Liz's apartment to question her about him and to offer financial help.
In East Germany, Leamas meets Fiedler. The two men engage in extended discussions, in which Leamas's pragmatism is contrasted with Fiedler's idealistic outlook. Leamas observes that the young, brilliant Fiedler is concerned about the righteousness of his motivation and the morality of his actions. Mundt, on the other hand, is a brutal, opportunistic mercenary, an ex-Nazi who joined the Communists after the war out of expediency, and who remains an anti-Semite.
The power struggle within the Abteilung is exposed when Mundt orders Fiedler and Leamas arrested and tortured. The leaders of the East German régime intervene after learning that Fiedler applied for an arrest warrant for Mundt that same day. Fiedler and Mundt are released, then summoned to present their cases to a tribunal convened in camera. At the trial, Leamas documents a series of secret bank account payments that Fiedler has matched to the movements of Mundt, while Fiedler presents other evidence implicating Mundt as a British agent.
Meanwhile, Liz, who had been invited to East Germany for a Communist Party information exchange, is forced to testify at the tribunal. Called by Mundt's attorney as a witness she admits that Smiley paid her apartment lease after visiting her and that she promised Leamas that she would not look for him after he disappeared. She also admits that he had said goodbye to her the night before he assaulted the grocer. Realising that their cover is blown, Leamas offers to tell all in exchange for Liz's freedom, admitting that Control gave him the mission to frame Mundt as a double agent. But when the tribunal halts the trial and arrests Fiedler, Leamas finally understands the true nature of Control and Smiley's scheme.
Liz is confined to a jail cell, but Mundt releases her and puts her in a car that will take her to freedom, with Leamas at the wheel. During their drive to Berlin, Leamas explains everything: Mundt is, in fact, a double agent reporting to Smiley. The target of Leamas's mission was Fiedler, not Mundt, because Fiedler was close to exposing Mundt. Leamas and Liz unwittingly provided Mundt with the means of discrediting Leamas, and in turn, Fiedler. Their intimate relationship facilitated the plan. Liz realizes to her horror that their actions have enabled the Circus to protect their asset, the despicable Mundt, at the expense of the thoughtful and idealistic Fiedler. Liz asks what will become of Fiedler; Leamas replies that he will most likely be executed.
Liz's love for Leamas overcomes her moral disgust and she accompanies him to a break in the wire fronting the Berlin Wall, from which they can climb the wall and escape to West Berlin. Leamas climbs to the top but, as he reaches down to help Liz, she is shot by Mundt operatives to avoid any possible suspicion of Leamas' escape. She falls and as Smiley calls out to Leamas from the other side of the wall, he hesitates. Then he climbs back down the Eastern side of the wall, to be shot and killed too.