If a relative is too toxic/difficult/batshit for YOU to deal with, its the SAME deal for your kids too. Protect your children from your MIL; even your DH has the measure of her finally. Let him deal with her. You do not have to and nor should your kids.
Children do need grandparents BUT emotionally healthy ones. His mother is not a safe person to be around and will continue to fill your kids heads with nonsense.
You are the parent. You get to make these decisions without apology or excessive justification. You can assure your childewn that you are making a wise and loving decision for them as well as yourself. I am not going to script what you should say because you are the only one who knows your children, but you must convey that this isn't up for negotiation. This is not a decision that the child gets to make. Yes, children usually love their grandparents. Children are often quite indiscriminate in their love which is why they need parents to guide them. Not every person is safe to have around and this is a good time to teach that important life lesson. The more matter-of-fact you are, the more matter-of-fact your children will be. When we act hysterical, they will usually reflect our hysteria. If you act anxious, they will act anxious. If you appear unsure, they will push. Model the reaction and attitude you want your children to adopt.
If you have another set of grandparents in the picture then focus on them. It is rare that both sets of grandparents are nasty. Emphasize to your children how much we enjoy being around grandma and grandpa so-and-so (the decent and loving grandparents). Cultivate your children's relationship with the decent, loving grandparents. Teach your children to be grateful for the decent, loving grandparents. Gratitude is a highly effective antidote to loss. Focus them on what they have, not what they don't have. Model that attitude of gratitude.
You will find that the children will eventually stop mentioning the loss of the toxic grandparent if you are not bringing it up. If you are talking about her in the hearing of your children then you are inviting them to keep talking about it, too. I can not over-emphasize the need for your explanation to a younger child to be calm, pragmatic, measured and short. Long explanations make you look defensive which will tend to peak the interest of the child and prompt him to push the issue. You can gauge what is appropriate information depending on the age of the child. If the child is older and has experienced or witnessed the grandparent's nastiness in action then you can say more.
Young children are not known for their long attention spans. This works in your favor. With younger children you have the advantage of distraction. It is easy enough to get the child's mind off onto another track. Every parent has done the distraction routine at one time or another. "Mommy, I want to see Nasty Nan today!" "Honey, we aren't going to see Nasty Nan today because we get to go to the park and eat ice cream." (Make up fun time on the spot if necessary for this distraction.) "Yay!!" says the kid and off we go. Subject changed, kid distracted. In time, Nasty Nan will fade from memory. Any bonding that may have occurred will dissipate in the process of time.
Remember, you are the parent. You're older and therefore more experienced which is the point of being the parent. The child is dependent on your good sense and protective wisdom. You're smarter than your child; use that to your advantage (such as using the distraction method). You are the final authority. This is not a negotiable issue. Your children do not get to decide on this one because they lack the understanding, wisdom, experience and good sense that, hopefully, you have. So don't look like you're unsure or open to quibble. You'll undermine yourself if you look anything but firm and resolved on it. Use your advantages as parent to smooth the effects of the cut-off. Over time this will all quiet down. Kids tend to accept what is. It will happen more quickly if you follow the above advice.
Most of all, do not operate from a fearful mindset. Don't be afraid of your children's possible, or actual, reactions. Don't be afraid that you are depriving them of something important by cutting off a set of grandparents. You are only "depriving" them of bad things. Reassure yourself with that truth. Family is not everything. Blood is not binding. What should connect us is how we treat each other with love and respect. This is always a good lesson to teach our little ones. If any part of you is unsure of your decision then, for Pete's sake, don't show it. Your resoluteness will go a long way toward reassuring your children that you are acting in everyone's best interest. If your children know that you love them, they are going to feel reassured that this decision is also based in your love for them. They will find an added sense of security to know that you, as their parent, are willing to protect them even at the cost of your relationship with your own parent(s). Rather than being fearful, see the plentiful opportunities in this. You are protecting your children from someone whom you've experienced as being abusive; you are reassuring your children that you are in charge and are watchful for their best interests (creates deep sense of security); you can teach healthy family values which include that family doesn't get a pass for abusive behaviour; you can strengthen and reinforce the healthy relationships in your extended family. Kids are less likely to feel like there is a void in their life if you fill it with good things.
Cutting off from his mother here is a good thing. No need to act otherwise. Your children will sense it is a good thing by how you behave. Model how you want them to respond and it is likely they will imitate. Don't be afraid of their questions. Kids are amazingly resilient and well-equipped to handle truth. Parents are supposed to protect their progeny. If your child doesn't agree with how you go about that don't worry. They will often disagree with your decisions for their best interests. Nothing new there. It is your job as parent to make the tough decisions. If you know it is the right decision then proceed with confidence. Showing confidence is a quality of leadership. As a parent you are supposed to be a leader. Lead...and they will likely follow.
Do read "Toxic Inlaws" by Susan Forward here to further understand the power and control dynamic.