Apolipoprotein E4 (APOE4) is the greatest known genetic risk factor for developing sporadic Alzheimer’s disease. How the interaction of APOE4 microglia with neurons differs from microglia expressing the disease-neutral APOE3 allele remains unknown. Here, we employ CRISPR-edited induced pluripotent stem cells (iPSCs) to dissect the impact of APOE4 in neuron-microglia communication. Our results reveal that APOE4 induces a lipid-accumulated state that renders microglia weakly responsive to neuronal activity. By examining the transcriptional signatures of APOE3 versus APOE4 microglia in response to neuronal conditioned media, we established that neuronal cues differentially induce a lipogenic program in APOE4 microglia that exacerbates pro-inflammatory signals. Through decreased uptake of extracellular fatty acids and lipoproteins, we identified that APOE4 microglia disrupts the coordinated activity of neuronal ensembles. These findings suggest that abnormal neuronal network-level disturbances observed in Alzheimer’s disease patients harboring APOE4 may in part be triggered by impairment in lipid homeostasis in non-neuronal cells.