In 1954, two U.S. Marshals â?? Edward "Teddy" Daniels and his new partner, Chuck Aule â?? travel to the Ashecliffe Hospital for the criminally insane on Shutter Island located in Boston Harbor. They are investigating the disappearance of patient Rachel Solando, who was incarcerated for drowning her three children. Their only clue is a cryptic note found hidden in Solando's room: "The law of 4; who is 67?" They arrive just before a storm hits, preventing their return to the mainland for a few days.

Daniels and Aule find the staff confrontational; Dr. John Cawley, the lead psychiatrist, refuses to turn over records, and they learn that Solando's doctor, Dr. Lester Sheehan, left the island on vacation immediately after her disappearance. Though they are given access to the hospital, they are told Ward C is off limits, while the lighthouse has already been searched. Whilst being interviewed, one patient secretly writes the word "RUN" in Daniels' notepad. Daniels starts to have migraine headaches from the hospital's atmosphere and experiences waking visions of his involvement in the Dachau liberation reprisals. He has disturbing dreams of his wife, Dolores Chanal, who was killed in a fire set by Andrew Laeddis, a local arsonist. In one instance Chanal tells Daniels that Solando is still on the island somewhere. The same applies to Andrew Laeddis who everyone claims was never there to begin with. Daniels later explains to Aule that locating the arsonist Laeddis was an ulterior personal motive for taking the case.

During their investigation Daniels and Aule find that Solando has abruptly resurfaced with no explanation as to her former whereabouts or how she escaped. This prompts Daniels to break into the restricted Ward C. There he encounters George Noyce who is a patient in solitary confinement. Noyce warns Daniels that the doctors are performing questionable experiments on the patients, some of whom are taken to the lighthouse to be lobotomized. Noyce warns Daniels that everyone else on the island, including Aule, is playing an elaborate game specifically designed for Daniels. Daniels regroups with Aule and is determined to investigate the lighthouse. While climbing the cliffs toward it they become separated, and Daniels later sees what he believes to be Aule's body on the rocks below. By the time he climbs down the body has disappeared, but he finds a cave where he discovers a woman in hiding who claims to be the real Rachel Solando. She states that she is a former psychiatrist at the hospital who discovered the experiments with psychotropic medication and trans-orbital lobotomy in an attempt to develop mind control techniques. Before she could report her findings to the authorities, however, she was forcibly committed to Ashecliffe as a patient. Daniels eventually hitches a ride back to the hospital without his missing partner.

Daniels is convinced that his partner Chuck Aule has been taken to the lighthouse where he discovers Dr. Cawley quietly waiting there for him. Cawley explains that Daniels arrived on the island alone and that Laeddis is actually Daniels himself. Daniels was incarcerated in Ward C for murdering his manic depressive wife after she drowned their three children. So the child-murdering "Solando" is actually his deceased wife. "Edward Daniels" and "Rachel Solando", as Dr. Cawley points out, are anagrams of "Andrew Laeddis" and "Dolores Chanal". Two real names produce two fictitious ones. This is the meaning behind the mysterious "Law of 4". Laeddis himself, as it turns out, is the actual 67th patient at Ashecliffe. Thus the question, "Who is 67?" is actually a reference to himself. Furthermore, the little girl from Andrew's recurring dreams is his own daughter, Rachel. The events of the last few days have all been designed by Dr. Cawley as a radical form of intervention therapy to break Andrew's conspiracy-laden insanity by allowing him to play out the role of Edward Daniels. Investigating the disappearance of a patient (Solando) was the "storyline". The guards, the staff and even the patients at Ashecliffe all played their various roles. Andrew's primary psychologist, Dr. Lester Sheehan, posed as Aule, primarily to shepherd Laeddis around, while a nurse posed as Solando. The migraine headaches Laeddis suffered resulted from being deprived of his prescribed medication. Daniels/Laeddis falls unconscious from the trauma of these revelations.

Andrew awakens in a hospital bed and is questioned by Cawley and Sheehan to determine whether or not he has lapsed back into his delusional state of mind. Laeddis passes their test with ease. Cawley notes, however, that they had previously achieved this state nine months prior to Andrew's regression, only for him to relapse, and this is to be his last chance at rehabilitation. Next morning, as Laeddis relaxes on the hospital steps with Doctor Sheehan, he again mentions looking for a way to escape from the island. Dr. Sheehan interprets this as a sign of a relapse and signals other staff members to approach. Andrew rises from the steps and calmly walks over to the awaiting orderlies and staff. His last comment to Dr. Sheehan, however, indicates that his 'relapse' may be merely an act. The comment is a speculation in the form of a rhetorical question: "Which would be worse â?? to live as a monster, or to die as a good man?

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