In 1954, U.S. Marshal Edward “Teddy” Daniels (Leonardo DiCaprio) and his new partner, Chuck Aule (Mark Ruffalo), go to the Ashecliffe Hospital for the criminally insane on Shutter Island located in Boston Harbor. They are investigating the disappearance of Rachel Solando, a patient who apparently vanished from a locked room. Dr. John Cawley (Ben Kingsley), the head psychiatrist, explains that Rachel was institutionalized after drowning her three children.
During the search for Rachel, Teddy sees a lighthouse but is told it has already been searched. He asks to see the hospital personnel files; Cawley refuses, but allows the Marshals to question the staff. They are frustrated to learn that Rachel’s psychiatrist, Dr. Sheehan, left on vacation after her disappearance. That night, Teddy has a strange dream in which he sees his wife Dolores Chanal (Michelle Williams), who was killed in a fire two years earlier. She tells Teddy that Rachel is still on the island, as is Andrew Laeddis, the arsonist responsible for Dolores’ death.
After interviewing patients from Rachel’s group therapy sessions, Teddy reveals to Chuck his ulterior motive for taking the investigation. Andrew Laeddis was sent to Ashecliffe for his crime and then disappeared. When Teddy decided to investigate the institution, he met a former patient, George Noyce, who claimed that Ashecliffe experimented on patients, so Teddy is determined to bring the institution down.
Cawley informs Teddy that Rachel has been found and presents her to him without logical explanation as to how she escaped or where she had been. The delusional Rachel (Emily Mortimer) mistakes Teddy for her husband who died in World War II, and then becomes very agitated. Later, Teddy develops increasingly severe migraine headaches. He has more strange dreams, followed by waking hallucinations related to World War II and the Dachau concentration camp, which he helped to liberate and taking part in the Dachau massacre. He eventually deduces that there is a patient who is being kept in secret – he believes this to be Andrew Laeddis. Trapped on the island by a storm, Teddy decides to search for Laeddis in Ward C, which he has not been permitted to investigate. Posing as an orderly, he enters the ward and finds George Noyce (Jackie Earle Haley), who states that the lighthouse is where lobotomies are performed. Noyce tells Teddy that the entire investigation is a game constructed for him, and that Chuck is not on his side.
Teddy rejoins Chuck and they head to the cliffs surrounding the island, intending to reach the lighthouse. They eventually become separated, and Teddy finds a woman hiding in a cave who claims to be the real Rachel Solando (Patricia Clarkson). She says that she was a psychiatrist at Ashecliffe until she found out about the experiments, and she was forcibly committed to ensure her silence. She explains that the hospital is using psychotropic medication in an attempt to develop mind control techniques and create “sleeper agent” spies. She says that Teddy has been similarly drugged since he arrived on the island.
Teddy returns to Ashecliffe, where Dr. Cawley tells him that he came to the island alone, without a partner; nobody seems to know Chuck. Eventually Teddy makes it to the lighthouse but finds nothing unusual, contrary to what he expected. At the top of the lighthouse, he finds Dr. Cawley, who reveals that Teddy is not Edward Daniels, but ex-Marshal Andrew Laeddis. Cawley says that he has been a patient at Ashecliffe for two years since he murdered Dolores Chanal, his manic depressivewife, after discovering she had drowned their children. Cawley explains that Rachel Solando never existed, and the woman in the cave was merely a product of Laeddis’ delusions. “Chuck” then arrives and reveals himself as Dr. Sheehan, Andrew’s psychiatrist, and the woman who was earlier presented as Solando turns out to be a nurse. Teddy and Chuck’s “sidearms” are revealed to be plastic toy guns. Sheehan and Cawley state that Andrew lived the fantasy of still being an active U.S. Marshal, searching for Andrew Laeddis as a means to disassociate himself from what he had done. They show him that the names “Edward Daniels” and “Rachel Solando” areanagrams of “Andrew Laeddis” and “Dolores Chanal”, respectively; Rachel was also the name of Laeddis’ drowned daughter who kept appearing in his dreams.
Cawley states that Andrew is the most violent patient in the hospital, having assaulted guards, orderlies, and patients including George Noyce, for having referred to him by his real name. This led the administrative board to demand a lobotomy as a permanent solution to his problem. Sheehan and Cawley explain that they decided to try an experimental therapy, in which they created the role play of Solando’s disappearance based on Andrew’s fantasy, with the hospital staff playing along. They hoped that by failing to uncover his mind-control conspiracy, Andrew would see reality and return to it permanently. It is also explained that Teddy’s physical pain and increased hallucinations are caused by withdrawal, having not been given his medication for the duration of the experiment. Teddy is initially doubtful, but after a lucid memory of the murder seems to come back to him, he collapses. The next morning he wakes up in a hospital bed and confesses before Dr. Cawley, Dr. Sheehan, and the Warden, all the details of the murder of Dolores and his delusions, to their satisfaction. Cawley explains to Andrew that treatment had brought Andrew to a point of clarity nine months earlier, but he regressed. He reminds Andrew that this is his final chance. Andrew expresses his gratitude toward Dr. Cawley for not giving up on him.
Some time later Andrew sits outside and once again calls Sheehan “Chuck” and mentions exposing the Island’s doings to the outside world. Sheehan sadly shakes his head at Dr. Cawley who is watching them from afar, and who gives the go-ahead for orderlies to approach and take Andrew for the lobotomy. Andrew tells Sheehan he’s been thinking whether it would be worse to “live as a monster, or die as a good man”. Questioning, Sheehan calls out to Andrew “Teddy,” but he does not turn around. He then walks away calmly with the orderlies.