TET family enzymes convert 5-methylcytosine (5mC) to 5-hydroxymethylcytosine (5hmC) in DNA. Here, we show that Tet1 and Tet2 are Oct4-regulated enzymes that together sustain 5hmC in mouse embryonic stem cells (ESCs) and are induced concomitantly with 5hmC during reprogramming of fibroblasts to induced pluripotent stem cells. ESCs depleted of Tet1 by RNAi show diminished expression of the Nodal antagonist Lefty1 and display hyperactive Nodal signaling and skewed differentiation into the endoderm-mesoderm lineage in embryoid bodies in vitro. In Fgf4- and heparin-supplemented culture conditions, Tet1-depleted ESCs activate the trophoblast stem cell lineage determinant Elf5 and can colonize the placenta in midgestation embryo chimeras. Consistent with these findings, Tet1-depleted ESCs form aggressive hemorrhagic teratomas with increased endoderm, reduced neuroectoderm, and ectopic appearance of trophoblastic giant cells. Thus, 5hmC is an epigenetic modification associated with the pluripotent state, and Tet1 functions to regulate the lineage differentiation potential of ESCs.