Ciliary transport is required for ciliogenesis, signal transduction, and trafficking of receptors to the primary cilium. Mutations in inositol polyphosphate 5-phosphatase E (INPP5E) have been associated with ciliary dysfunction; however, its role in regulating ciliary phosphoinositides is unknown. Here we report that in neural stem cells, phosphatidylinositol 4-phosphate (PI4P) is found in high levels in cilia whereas phosphatidylinositol (4,5)-bisphosphate (PI(4,5)P2) is not detectable. Upon INPP5E inactivation, PI(4,5)P2 accumulates at the ciliary tip whereas PI4P is depleted. This is accompanied by recruitment of the PI(4,5)P2-interacting protein TULP3 to the ciliary membrane, along with Gpr161. This results in an increased production of cAMP and a repression of the Shh transcription gene Gli1. Our results reveal the link between ciliary regulation of phosphoinositides by INPP5E and Shh regulation via ciliary trafficking of TULP3/Gpr161 and also provide mechanistic insight into ciliary alterations found in Joubert and MORM syndromes resulting from INPP5E mutations.