My sister has a 7 year old grandson who she has custody of becuase her daughter is addicted to heroine. The boy gets that his mom is not normal.
I agree with above. The reality is she is sick and she is in a place where they will help her get better. I think kids instinctively know the truth - and what she'll need (as I am sure you know) is to know that it is not her fault, there are people who love her and her world is safe so she can be a kid and do kid things without worrying.
One thing my sister did was get her boys (there is also a 4 year old) a counselor through children's services. It helps a ton becuase they do play therapy and help children process their feelings. Kids can't often verbalize what they are feeling so this helps them heal and let go.
So no matter what you tell your grand-daughter, it might be worth a call to children's services in your community to see if you could get her into counseling. This story is not over and sometimes getting something like this started early avoids a lot of pain later.
Prayers for you and your grand-daughter,