John Bickerton of England finished alone in second at 16-under par while Massimo Scarpa, Stephen Dodd, defending champion Niclas Fasth and overnight leader Massimo Florioli shared third at minus 14.
With the victory, Smyth became the oldest winner ever in European Tour history. At 48 years and 34 days, Smyth was 22 days older than Neil Coles when he won the 1982 Sanyo Open.
This is the eighth title on the European Tour for Smyth, but his first since the 1993 Madrid Open. He has now won tournaments in each of the last four decades with his first win coming at the Sun Alliance European Match Play Championship in 1979.
'I'm ecstatic,' said Smyth. 'I was almost afraid to think of winning. I've won seven times previously and played Ryder Cup but when you haven't won for so long it is like this elusive dream.'
Smyth bogeyed the opening hole but recovered with a birdie at No. 3.
The par-5 7th proved to be the crucial hole of the round for Smyth. He pulled his drive into the trees and when it looked like he had no out, Smyth nailed a wedge shot over a tree and into the fairway. Smyth then hit a 7-iron to four feet for a birdie and a front-nine 35.
'I really had very little chance of getting it out,' said Smyth, referring to his second at No. 7. 'I took a huge gamble going through a gap over my head. That's where things changed.'
Smyth birdied the 10th and then nailed a 4-iron to a foot at the par-5 11th for a tap-in eagle. He holed a four-footer for bogey at No. 13 but then ran off three birdies in a row, starting at 14, to get to 18-under and wrap up the championship.
'This is huge for me,' said the Irishman. 'It's very hard to win on Tour these days. It will take at least a week to sink in.'
Bickerton carded a final-round 69 for his 16-under total. He made back-to-back birdies at Nos. 9 and 10 but ran into trouble at 11.
He found water on the left and despite attempting to play his shot with his shoes and socks off, Bickerton found more trouble and could do no better than bogey-six.
'I just let a couple of holes slip,' said Bickerton, who took his third runner-up finish as he still searches for his first win on tour. 'But then again I'm happy. Second - again.'
Fasth moved up the leaderboard with five birdies on the back nine but fell off with bogeys at the final two holes.
A double-bogey at the fourth hurt Florioli's chances of winning the championship as he posted a final-round 1-over 73.
Pehr Magnebrant and David Lynn took seventh at 13-under and Jose Manuel Lara and Craig Hainline were ninth at minus 12.
Click here for full-field scores from the Madeira Island Open