Stem cells reside in niches that provide signals to maintain self-renewal, and differentiation is viewed as a passive process that depends on losing access to these signals. Here we demonstrate that differentiation of somatic cyst stem cells (CySCs) in the Drosophila testis is actively promoted by PI3K/Tor signaling, as CySCs lacking PI3K/Tor activity cannot properly differentiate. We find that an insulin peptide produced by somatic cells immediately outside of the stem cell niche acts locally to promote somatic differentiation through Insulin receptor (InR) activation. These results indicate that there is a local ‘differentiation’ niche which upregulates PI3K/Tor signaling in the early daughters of CySCs. Finally, we demonstrate that CySCs secrete the Dilp-binding protein ImpL2, the Drosophila homolog of IGFBP7, into the stem cell niche, which blocks InR activation in CySCs. Thus, we show that somatic cell differentiation is controlled by PI3K/Tor signaling downstream of InR and that local production of positive and negative InR signals regulate the differentiation niche. These results support a model in which leaving the stem cell niche and initiating differentiation is actively induced by signaling.