Lineage-restricted cells can be reprogrammed to a pluripotent state known as induced pluripotent stem (iPS) cells through overexpression of 4 transcription factors. iPS cells are similar to human embryonic stem (hES) cells and have the same ability to generate all the cells of the human body, including blood cells. However, this process is extremely inefficient and to date has been unsuccessful at differentiating iPS into hematopoietic stem cells (HSCs). We hypothesized that iPS cells, injected into NOD.Cg-Prkdc^scid Il2rg^tm1Wjl/SzJ immunocompromised (NSG) mice could give rise to hematopoietic stem/progenitor cells (HSPCs) during teratoma formation. Here, we report a novel in vivo system in which human iPS cells differentiate within teratomas to derive functional myeloid and lymphoid cells. Similarly, HSPCs can be isolated from teratoma parenchyma and reconstitute a human immune system when transplanted into immunodeficient mice. Our data provide evidence that in vivo generation of patient customized cells is feasible, providing materials that could be useful for transplantation, human antibody generation, and drug screening applications.