Dysfunction and loss of retinal pigment epithelium (RPE) leads to degeneration of photoreceptors in age-related macular degeneration and subtypes of retinitis pigmentosa. Human embryonic stem cells (hESCs) may serve as an unlimited source of RPE cells for transplantation in these blinding conditions. Here we show the directed differentiation of hESCs toward an RPE fate under defined culture conditions. We demonstrate that nicotinamide promotes the differentiation of hESCs to neural and subsequently to RPE fate. In the presence of nicotinamide, factors from the TGF-beta superfamily, which presumably pattern RPE development during embryogenesis, further direct RPE differentiation. The hESC-derived pigmented cells exhibit the morphology, marker expression, and function of authentic RPE and rescue retinal structure and function after transplantation to an animal model of retinal degeneration caused by RPE dysfunction. These results are an important step toward the future use of hESCs to replenish RPE in blinding diseases.