What a great idea! I taught preschool for a long time, and we painted alot with pudding, but I do believe that will eventually mold or go bad and have to be thrown away. I have heard of some parents spraying over it with a sealant (used for crafts) to kind of preserve it, but don't know how many years that lasted. Same with the KoolAid/water - give it a try if you'd like, can't hurt her!
Of course the Crayola and other non-toxics would be fine if she got it into her mouth - it teaches some little ones to NEVER do that again! :D
What I did with my own when they were little was to paint their hands/feet and make Reindeer, or wreaths, or Santa, or C-mas Trees. Sometimes we did it on paper and framed them for GPs or sometimes made sweatshirts or Tshirts. I still have a blue sweatshirt with white handprint snowflakes that all 3 of mine did when they were 4, 2 & 1 year olds - I adore it still! Also paint or write the year on it, just in case you have more kids and forget like me! The only thing with doing the shirts is that is HAS to be the permanent acrylic craft paints (not Tempera) mixed with fabric medium to make sure it doesn't wash out. I've had my sweatshirt for 8 years now and it still has every bit of paint on it! So if you ever choose this route, make sure she is naked or wearing paint clothes - as well as yourself, and that you will not be ruining anything near you! Cover table/floor with plastic!
One other idea - we have also made ornaments from craft foam sheets - there are lots of websites that show how to trace little hands/feet and make them - I have many Santas on my tree that my kids made in preschool and we love to hold their hands up to them every year to compare! My 12 yo son's hand is ALOT bigger than when he was 5!
Her grandparents (and you) will treasure these things when she is older!