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"The last time I talked to her, she was doing fine. Would you like to look at some pictures of the children/have another cup of coffee/watch TV?"
Note the deflection and changing the subject. You DO NOT keep telling her her sister is dead, because keep in mind (and tell your husband), not only would you upset her terribly, but she may also be thinking of her sisterly relationship when they were children. To her, you may be telling her not that an elderly sister has died, but rather that a CHILD has died.
My mother's reality eventually settled somewhere in her high school years. She had an imaginary husband who had in reality been her high school boyfriend, and as a couple in her mind they went from being two elderly people who'd rediscovered each other after 70 years to two 16-year-olds. If my mother had asked about her sister and I'd told her she'd died, she had thought I was telling her that her 20-year-old sister was dead. That would have devastated her even more than her sister's actual death at age 90.
DO NOT continue telling her. To do otherwise is cruel and heartless, and you can tell your husband I said so.
to think for a minute how he has felt whenever he first heard the news of the death of someone with whom he was close (if he has ever lost anyone). That initial shock is so incredibly painful, and then your heart and mind slowly adjusts to the new reality of the loss. That adjustment of heart and mind is NOT happening for your aunt - she is suffering the initial pain every single time she hears the news! It is like a punch in the gut. Only a cruel person would keep telling her this and watching her get upset.
It would not be a lie to say "She's not sick or hurting any more."
Then redirect the conversation.
Yes, tell the truth. Keep stabbing her in the heart over and over again.
Doesn't your husband see how the truth hurts his aunt? Why does he want to do that? Why? Honesty is the best policy? Blind honesty is stupid. If a dangerous guy/murderer comes looking for you, is he going to be honest and tell that creep where to find you?
Instead, you can ask questions to encourage her to talk about what she does remember. That might be as recent as the visit to hospice, or it might go back earlier. You confirm the accurate recollections and steer her away from the mistaken ones.
Was she especially close to this sister?
Be aware of her words, sometimes she may remember her sister was ill.. if so, another answer could include "Well she had been ill but has good Doctors & Nurses & is getting the treatment she needs".
I think *how* it's said matters too eg: a worried sounding reply vs a cheerful, confident "oh she was fine when I talked to her a while back".
Then pivot into fond or fun memories she has of them as girls.
I would say you don't know. Not a lie, you don't.
Haven't seen her for awhile. Not a lie, you haven't.
Last I heard she was fine. Not a lie, her struggles are over.
See how easy it is to not devastate her repeatedly without an actual lie?
If your husband and nephew disagrees, it may be helpful for them to learn more about dementia to fully understand.
Put opinions aside now and rely on what the dementia experts advise in this situation. Here is an article on the subject with links to other topics about AD and dementia and how to handle certain situations:
https://www.helpforalzheimersfamilies.com/learn/quick-tips/confusion-and-memory-loss/what-to-do-when-a-loved-one-with-alzheimers-forgets-that-someone-is-dead/
A good book to pick up is The 36 Hour Day which is full of useful information for both you and your husband to learn as you try to help your aunt with her condition.
Good luck to you