A goal in human embryonic stem cell (hESC) research is the faithful differentiation to given cell types such as neural lineages. During embryonic development, a basement membrane surrounds the neural plate that forms a tight, apico-basolaterally polarized epithelium before closing to form a neural tube with a single lumen. Here we show that the three-dimensional epithelial cyst culture of hESCs in Matrigel combined with neural induction results in a quantitative conversion into neuroepithelial cysts containing a single lumen. Cells attain a defined neuroepithelial identity by 5 days. The neuroepithelial cysts naturally generate retinal epithelium, in part due to IGF-1/insulin signaling. We demonstrate the utility of this epithelial culture approach by achieving a quantitative production of retinal pigment epithelial (RPE) cells from hESCs within 30 days. Direct transplantation of this RPE into a rat model of retinal degeneration without any selection or expansion of the cells results in the formation of a donor-derived RPE monolayer that rescues photoreceptor cells. The cyst method for neuroepithelial differentiation of pluripotent stem cells is not only of importance for RPE generation but will also be relevant to the production of other neuronal cell types and for reconstituting complex patterning events from three-dimensional neuroepithelia.