The Swiss took the first set with relative ease and looked set to win his 101st ATP tour title.
He turned on the style in the first game as he hit a superb ‘tweener’ shot after being lobbed at the net.
But Thiem rallied back in the second set, and kept the pace with Federer in the third to take the victory.
Thiem had lost twice in Masters 1000 finals, both in Madrid, and he admitted that he felt the nerves, but praised Federer as a “legend” of tennis.
Speaking after the game, Federer was full of class and admitted he was beaten by the better man.
“It’s been a great week for me even though it didn’t work out,” he said.
“But what a week Dominic has had, many congratulations to him.
“Wonderful playing throughout the week.
“He deserves it.”
Federer will now turn his attentions to the Miami open, which begins this week.
But he insisted that he would be back to play again next year, putting an end to any speculation that he would retire at the end of this season.
“I’ve had a great week here with my family, and I hope we can come back next year,” he continued.
“A big thank you to everybody who has made this week what it was.
“We’ve had a wonderful week, and thank you again very much.
“Dominic, congratulations again.”