Formation of inner and outer cells of the mouse embryo distinguishes pluripotent inner cell mass (ICM) from differentiating trophectoderm (TE). Carm1, which methylates histone H3R17 and R26, directs cells to ICM rather that TE. To understand the mechanism by which this epigenetic modification directs cell fate, we generated embryos with in vivo-labeled cells of different Carm1 levels, using time-lapse imaging to reveal dynamics of their behavior, and related this to cell polarization. This shows that Carm1 affects cell fate by promoting asymmetric divisions, that direct one daughter cell inside, and cell engulfment, where neighboring cells with lower Carm1 levels compete for outside positions. This is associated with changes to the expression pattern and spatial distribution of cell polarity proteins: Cells with higher Carm1 levels show reduced expression and apical localization of Par3 and a dramatic increase in expression of PKCII, antagonist of the apical protein aPKC. Expression and basolateral localization of the mouse Par1 homologue, EMK1, increases concomitantly. Increased Carm1 also reduces Cdx2 expression, a transcription factor key for TE differentiation. These results demonstrate how the extent of a specific epigenetic modification could affect expression of cell polarity and fate-determining genes to ensure lineage allocation in the mouse embryo.