When I had my adopted grandma in my house her last 5 1/2 weeks, everyone told me to NOT let her die in my house because it would traumatize my children.
I concluded that "death" is a normal part of life. She did die in my home. My children were GLAD she was here....she wasn't alone. They were glad to be a part of it. Just a few minutes before she died (after 2 bouts of cardiac arrest) I went to my then 5 year old son and said "you asked God to help Grandma Gladys turn 92. Now it is time to ask him to take her to be with him". His response? A stoic...Yes ma'am...I can do that.
Death was hidden from me as a child. It took me a long time to accept it and learn to deal with it as a result. If they had helped me to see it as a real part of life, i woudl have been much better off.
Personally....I urge you to be straight forward with your daughter. a 3 year old knows a heck of a lot more than we ever give them credit for. Be honest with her now and she will know later in life that she can trust you.
Even something as simple as "grandma's body is getting old and tired. Grandma loves all of us but she is ready to leave this life and go have a new life with God...a life where she will not have pain. We don't know exactly when she will leave, but it will be soon." Then allow the girl to interact with her grandma as much as is humanly possible....it will make a huge difference for the both of them.
Oh - and don't hide your emotions. If you hide your emotions...you are tellign yoru children that emotions are bad, they will learn to bottle their feelings, be silent, and have tremendous dificulty communicating. (I speak that with personal first hand experience of what was slammed on me as a child.)
Be at peace (yes it's possible to do this while expressing your emotions). Know that your MIL makes the ultimate choice as to when she leaves. It is her body that dies...not her. And that she WILL move on to be with God.
If you just need to talk to someone outside the situation....email me here with your number and i'll be happy to call you. (I've personally dealt with hospice several times and helped others who hospice was not helpful to)
Blessings and peace in abundance.
S.