C.--wow, you've gotten great responses!
I am so sorry your family is losing this woman ...
When my oldest was about 2 or 3, her great grandmother and her great aunt died. Both were local, and we visited them with increasing frequency as they deteriorated (emphysema and cancer, respectively).
I don't know if you are local to this grandma, but it sound's like you are. I used extremely concrete terms: as we get older, our bodies stop working very well ... and eventually our bodies stop working altogether. My daughter could really see that process, since we were visiting all the time--we watched her GG die from being less and less able to breathe, having also finally gone blind a year before--so being really straight up was best. Acknowledge the child's very real (and otherwise scary) experience.
Since this death is coming right up, be sure to build the whole picture for her, though, or she won't see the pattern ("you remember how your grandma started being too tired to come to see us very much last summer? and then at Christmas we went to visit her but could only stay a little while, and she couldn't lift heavy things?") ... otherwise she'll get worried every time a grownup gets sick.
As far as souls, I am Catholic but grew up with no Catholic peers, so I've always from the start said to my children "We believe that [blah blah blah]" ... when the kids get old enough to ask why I always frame the idea that way, then I explain that "a lot of people don't believe that, they believe other things happen" (with added explanations as appropriate).
I know it seems early to start that, but when kids get into school or daycare and someone insists that something their parents have told them isn't true, they either get defensive (which of course leads to problems) or they get scared because they don't know what to trust (rather the opposite of us building security for them, sigh). So I communicated my confidence in our belief-system, but also allowed openness-of-heart for all the many ways other kids and families might be facing dying, even at the same funerals/wakes (even within our family we needed that!).
My second child, who was a baby during both deaths, actually still gets hung up about his GG dying (she died barely within his memory; his GA died too early for him to notice). We had her ashes for a long time (long story) and he would ask to have them taken down and hold them in his lap ... for him, having to walk him through the emotional "it's OK that people die" was more important than the physical.
I was so honored to have the opportunity to watch and accompany those deaths ... all the natural (non-accident, non-suicide) deaths in my family were when I was younger and far away, so I never had any direct experience. There is a beauty to a natural life drawing to a close, even in the sadness ... but I'm really the only person I've found that sees it that way ... but I thought I'd offer it as a possibility. If she's got good hospice care, talking your daughter through "see how much more at peace she's getting now?" might also be good.
Anyhow, these approaches have allowed my daughter to be secure in her faith while being supportive of others' belief systems in her school, and all my kids have a pretty strong handle on "we need to take physical care of ourselves" (eg., no smoking, eat healthy)--which are long-term benefits to my effort to bring them through those immediate difficult life events.
Dunno if you are religious or not. If not, I was recently reading a beautiful set of thoughts about the patterns of the universe, which thoughts could build into a nice, non-religious way of considering each person's eternal impact on the world; you can email me if you want more of that ...
God bless (or your cultural equivalent)!
--K.
PS oh, I totally forgot: the cremation thing(/burial). My son was always wanting to "see" her ... that was why we started the holding-the-ashes-in-his-lap thing. We had to really explain to him that when the soul left the body is was OK that we burned the body, or that a lot of people chose to get buried and turn into dirt (we didn't introduce embalming, as in our families it won't apply) ... things to consider ahead of time ...