Should I let this ruin our vacation?

I'm sorry for your loss, but I don't see how letting his passing ruin your vacation is helping anyone. If you're a religious person, maybe go to a place of worship and say a prayer for him. If you're not, then maybe write a letter to his family saying what a wonderful friend he was and how much you'll miss him. I think you need to do something now to address the hurt that you're feeling, with the plan that when you return home you will pay your respects in person.

Of course you are hurting from the loss. maybe you and your sister could set aside a little time (a meal, day trip somewhere together, evening on the beach or whatever) to share your grief and focus on honoring the memory of your friend somehow, then do the best you can to get back in the vacation mode. If you know when the funeral is going to be held, maybe you could coordinate with that time for your own personal memorial.

If your schedules are already nailed down send regrets and let the family know that you wanted to come to the funeral but were locked into the vacation package.