Sponges are important components of many marine communities and perform key functional roles. Little is known on the processes that drive larval dispersal and habitat selection in sponges, and in particular under stress scenarios. The increase in sediment in the marine environment is a growing concern for the health of ecosystems, but scarce information exists on the effects of sediment on sponge larvae. This study assessed the effects of suspended and deposited sediment on the larva of Carteriospongia foliascens. A suspended sediment concentration (SSC) of 100 mg L−1 caused homogenisation of the natural pattern of phototactic responses, leading to 100% of photonegative behaviours and a reduction of swim speeds by 27%. After 24 h exposure to suspended sediments, fine particles were found attached to larval cilia, causing abnormal swimming behaviours. Larvae did not have the ability to remove the attached sediment that led to a transformation of the larval body into a cocoon-like morphology and death. Mortality tripled from 3 mg L−1 (9%) to 300 mg L−1 (30%) and the relative SSC EC10 and EC50 values corresponded to 2.6 mg L−1 and 17.6 mg L−1 respectively. Survival, as determined by live swimming larvae, exceeded 50% even in the highest SSC of 300 mg L−1, however settlement success decreased by ~20%. Larvae were able to settle onto substrate having deposited sediment levels (DSLs) up to 3 mg cm−2 (~24%), but recorded a 25 × chance of dislodgement compared to settlers on substrate with DSL of 0.3 mg cm−2. Larvae avoided settling onto substrates with DSLs >10 mg cm−2 and preferentially settled onto alternative vertical substrate that were free of sediment. While C. foliascens larvae have some ability to survive and settle through conditions of elevated sediment, detrimental effects are also clear.