I'm so glad to hear that your husband has agreed with you. But, not to be a downer,
the hard part is NOT the agreeing, it is the follow through. He can't make rules and let her break them because it is easier not to confront her. This is how you train someone not to respect you. I see it with kids (and sometimes my own!) when I'm too tired to enforce the rules.
Make a list of what you will accept in your life from here on out. WRITTEN DOWN. The written down part is important. !!!! Not more than 10 or so things that cover most possibilities.
The one I think is most important is that the kids are NEVER with her without you there, NEVER talk to her without you there. MIL is a MASTER manipulater and your DH will be more easily manipulated and may not see warning signs that you do.
Make sure you BOTH know (you and your DH and also the MIL) what will happen if any of these rules are broken. If she disrespects you do you end all contact for x amt of time? Forever? Give her one warning?? and then the next time it is NO contact forever? If one rule is broken is it only phone visits? Don't compromise because you feel so glad DH is standing up for you. You will never get a better shot at this.
This seems a little bit crazy but you don't want gray areas. Not for her and not for your husband. She does not understand gray areas. This is now a black and white situation.
I can see your point about not wanting your husband to have custody with her nearby. I have never tried to commit anyone. I don't know if you need documentation or how much. This might be a good thing to find out.
How does your DH plan to explain the new situation to your MIL? Letter? Phone? In person? Whatever you decide be prepared for crazy, maybe not when you give her the rules but when you actually follow through. Although I'd be prepared for crazy anytime really.
If she has said she wants to shoot her husband does she have a gun?
Man, I hope this works out for you. Please keep us posted.