I know in the movie that he was stabbed then he fell off of his tower onto a water wheel. But my friend says that didn't happen in the books.
Wikipedia has the answer..
He dies in the Shire when his throat is cut.
Merry, Pippin, Frodo and Sam make plans to set things right once more. With the help of the Cotton family, they lead an uprising of Hobbits and are victorious at the Battle of Bywater which effectively frees the Shire. At the very doorstep of Bag End, they meet Sharkey, who is revealed to be the fallen wizard Saruman, and his much-abused servant Gríma. After Saruman reveals that Gríma has murdered (and probably cannibalized) Lotho, Gríma then jumps on his back and cuts his throat. Gríma is himself slain by hobbit archers as he attempts to escape. Saruman's soul is blown away into the east, and his body decays instantly into a skeleton.
The novel has it thus...
Saruman laughed. ‘You do what Sharkey says, always, don’t you, Worm? Well, now he says: follow!’ He kicked Wormtongue in the face as he grovelled, and turned and made off. But at that something snapped: suddenly Wormtongue rose up, drawing a hidden knife, and then with a snarl like a dog he sprang on Saruman’s back, jerked his head back, cut his throat, and with a yell ran off down the lane. Before Frodo could recover or speak a word, three hobbit-bows twanged and Wormtongue fell dead.
To the dismay of those that stood by, about the body of Saruman a grey mist gathered, and rising slowly to a great height like smoke from a fire, as a pale shrouded figure it loomed over the Hill. For a moment it wavered, looking to the West; but out of the West came a cold wind, and it bent away, and with a sigh dissolved into nothing.
The Return of the King (Chapter 8 - The Scouring of the Shire) - JRR Tolkien
This is a different ending to the movie as Jackson elected not to include the Scouring of the Shire in the movie