Allen was born in Carrollton, rural western Illinois, the daughter of Patricia A. (née Howell), a teacher, and Carroll Thompson Allen, an FBI agent.Allen spent her first 10 years traveling around the country with her parents and two sisters. After graduating from DuVal Senior High School, in Lanham, Maryland at 17, she moved to New York to study art and design at Fashion Institute of Technology. She later attended the University of Maryland, College Park and spent time traveling through South and Central America. In 1974, Allen joined a theater group and three years later moved back to New York and studied at the Lee Strasberg Theater Institute.

In 1978, Allen made her major film debut in National Lampoon's Animal House. Her next two appearances were in The Wanderers in 1979 and A Small Circle of Friends in 1980, where she played one of three radical college students during the 1960s. The United Artists-release of that film received only limited theatrical exposure, ultimately grossing under $1 million.

Her career-changing role came with the blockbuster hit Raiders of the Lost Ark (1981), directed by Steven Spielberg, in which she played the feisty heroine Marion Ravenwood, love interest of Indiana Jones (Harrison Ford. Allen won a Saturn Award for Best Actress for her performance.

Allen debuted on Broadway in the 1982 production The Monday After The Miracle. After a few small films, including the leading role in the Paris-set romantic drama Until September (1984), directed by Richard Marquand, and other stage appearances, she co-starred in the successful science-fiction film Starman (1984) with Jeff Bridges

She often took breaks from movie roles to concentrate on stage acting.

In 1987, Allen appeared as Laura in the Paul Newmandirected version of the Tennessee Williams play "The Glass Menagerie" with John Malkovich and Joanne Woodward.

A year later, Allen returned to the big screen as Bill Murray's long-lost love Claire in the Christmas comedy Scrooged. In 1990, she portrayed the doomed crew member Christa McAuliffe in the controversial television movie Challenger, based on the Space Shuttle Challenger disaster.

Allen subsequently appeared in Spike Lee's Malcolm X (1992), in a small supporting role in The Perfect Storm (2000) and In the Bedroom (2001). She made guest appearances on television's Law & Order (1996) and Law & Order: Special Victims Unit (2001). The actress also starred in the short-lived series The Road Home (1994) and portrayed Dr. Clare Burton in the video game Ripper (1996).

Allen reprised her best-known role as Marion for the 2008 sequel Indiana Jones and the Kingdom of the Crystal Skull, in which she renews her relationship with Indy and reveals to him that they have a son named Mutt Williams.