After the fateful encounter with heavenly lightning, both Ne Zha and Ao Bing find themselves in an extraordinary predicament when their physical forms are utterly destroyed. In a desperate attempt to save their souls from fading away, Master Taiyi Zhenren utilizes his powerful Seven-colored Sacred Lotus to restore their bodies, although they remain frail and vulnerable. Meanwhile, believing his son is lost forever, Ao Guang, the Dragon King of the East Sea, unleashes his wrath upon the town, unleashing the long-imprisoned monsters that lie beneath his palace, including the other three Dragon Kings of the Four Seas. In a fierce battle to defend Chentang Pass, Ao Bing's new body cannot withstand the immense strain and crumbles to pieces.
In the midst of this chaos, Ao Guang proposes a ceasefire agreement: for the next seven days, Ao Bing and Ne Zha will share the body of Ne Zha, navigating through the trials of Immortal Wuliang to ascend to become an xian. Successfully completing these trials will reward them with a potion that can regenerate the Sacred Lotus and recreate a new body for Ao Bing, thus allowing peace to return as Ao Guang's forces withdraw. Each trial presents a new challenge, requiring the candidates to execute missions typically performed by the heavenly Taoist sect's demon-hunting forces. To conceal his demonic identity, Ne Zha consumes a sleeping pill, enabling Ao Bing to take full control of their shared body for a limited time. Together, they conquer the first two trials, battling against a band of marmot bandits and a master who specializes in training demons.
Simultaneously, Ao Guang entrusts Master Shen Gongbao, a Leopard demon who has achieved a rank in the heavenly court, to oversee Chentang Pass along with the three other Dragon Kings. In a shocking turn of events, Gongbao has a reunion with his younger sibling, Shen Xiaobao, who recounts the horrific siege perpetrated by the sect that resulted in the destruction of their hometown, including the tragic incident involving Ne Zha against their father. Xiaobao’s heroic efforts to shield his father result in his mortality, leaving Gongbao grief-stricken as he cradles his fallen brother. As preparations for the upcoming trial continue, tragedy strikes Chentang Pass, which suffers a massacre at the hands of the dragons. Fuelling his anger, Ne Zha rises to action, independently completing the last trial and achieving the rank of xian while securing the potion essential for Ao Bing's revival.
As Taiyi works to restore Ao Bing's body, Ne Zha makes a shocking choice by abandoning his companion to join Wuliang's forces in a vengeful plan to entrap the dragons within the sect’s cauldron, where they are destined to be transformed into elixirs for their revenge on the destruction of Chentang Pass.
In a surprising twist, Ne Zha’s parents, alongside Ao Bing and Master Taiyi, confront the truth about the situation. Flashbacks reveal Wuliang’s brutal attack on Chentang Pass, while Gongbao uncovers the betrayal of the Dragon Kings who ally with Wuliang, thus orchestrating a bloodbath that frames Ao Guang for the violence, serving as a justification for the sect’s authority to eradicate the dragons. In a noble act of defiance, Gongbao stands his ground against the assault, buying precious time for Ne Zha's parents to survive amid the chaos.
As fierce battles erupt, Wuliang manages to capture Ne Zha and his allies, throwing them into the cauldron. The devastating moment strikes when Ne Zha’s mother loses her life in her son's arms, pushing Ne Zha to tap into the cauldron's formidable samadhi fire, which strengthens his new physique. With newfound vigor and an alliance with the dragons and previous captives, Ne Zha and Ao Bing break free from the confines of the cauldron. Together, they unite against the heavenly forces, compelling them to retreat. In the aftermath of the conflict, Ao Guang leads the surviving dragons into hiding under the sea, allowing Ao Bing to remain behind to reveal Wuliang's true nature.
In a post-credits scene, Wuliang visits a hidden prison to negotiate with the captive Shen Gongbao and his father. However, a twist of fate leaves them trapped in the prison for a decade, as Wuliang cunningly hypnotizes the guard into slumber. Meanwhile, Ne Zha's older xian brothers take center stage as they are summoned to meet with Wuliang, hinting at future confrontations and alliances.
