Iwai was born in Sendai, Miyagi, Japan. He attended Yokohama National University, graduating in 1987.

In 1988 he started out in the Japanese entertainment industry by directing TV dramas and music videos. Then, in 1993, his TV drama, Fireworks, brought him critical praise and the Directors Guild of Japan New Directors Award for his portrayal of a group of children in the town of Iioka.

In 1995 he went on to start his career in feature films, starting with the box-office hit Love Letter, in which he cast pop singer Miho Nakayama in dual roles. Love Letter also launched the movie career of Miki Sakai who won a Japanese Academy Award as 'Newcomer of the Year' for her portrayal of Itsuki Fujii as a young girl. Iwai collaborated with Cinematographer Noboru Shinoda to produce a film praised for its evocative winter cinematography. Love Letter made an impact in other east Asian countries too, notably South Korea where the film's success helped break down the post-World War II barriers to Japanese films being shown there.

In 1996 came the commercial and critical success of Swallowtail Butterfly, a multifaceted story of the fictional Yen Town, a city of immigrants in search of hope and a better life with three separate and distinct main characters. Ageha (Ayumi Ito), an orphaned teenage girl, Glico (Chara), a prostitute turned pop star, and Feihong (Hiroshi Mikami), an immigrant who manages Glico's career and owns the Yen Town club. He also wrote the lyrics of a theme song for the film Swallowtail Butterfly (Ai no Uta) with Chara and Takeshi Kobayashi.

He has recently directed a commercial airing in Japan featuring Matsu Takako, whom he has not worked with since 1998.

Iwai enjoyed another kind of success with this film as well, having teamed up with Takeshi Kobayashi to create the music for the film and the Yen Town Band, headed by Pop star Chara. The band they created became a commercial hit in Japan. He would team up with Kobayashi again in 2001 for the harrowing High School Drama All About Lily Chou-Chou. Kobayashi would create the music for the titular pop star, Lily Chou-Chou (voiced by Japanese singer Salyu), that is spread through the film (as well as Debussy), and later be released as an album entitled Kokyu (Breathe).

In 2002 he released a short, ARITA, in which he composed his own film score for the first time. In 2004 Iwai released Hana & Alice, his first comedy. He once again composed the film score himself.

October, 2006 sees the Iwai produced film Rainbow Song released in Japan. The film is directed by Naoto Kumazawa and was written by Ami Sakurai. It stars previous Iwai actors Hayato Ichihara, Yu Aoi and Shoko Aida. Also in 2006, Iwai spent time documenting and interviewing Kon Ichikawa while filming The Inugamis (Inugamike no ichizoku - 2006) to create a feature-length documentary about the director's life.

A more recent project, a piece he wrote about the Japanese indie rock scene in the early 1990s called Bandage, was released on January 16, 2010. Apart from being in charge of the music production, "Bandage" represents Takeshi Kobayashi's first time as a movie Director. The project was originally taken by Ryuhei Kitamura, but was dropped in 2006. The filming started in 2008 and Kobayashi chose a completely different cast for the movie, casting j-pop singer Jin Akanishi and Kie Kitano for the main roles. It also included other actors who have worked with Iwai before, such as Ayumi Ito and Hideyuki Kasahara. The release of the horror film Vampire marked his English-language film debut.