Everything else fits on the boot drive and the thinning process is quite solid. My Photos library is now at 120 GB alone so my one device that downloads the full versions of everything so I can make a separate backup has that photo library on an external drive and not the 256 SSD. I'm quite happy with 200 GB in the cloud for the past three years and three Mac with 256 SSD. Just be sure to store files outside the buckets that sync locally and I think you'll be able to have iCloud storage for things you don't want on your Mac. Then you'll want to let the machine get in balance with iCloud (which can take hours if you are in the 200 GB storage size for iCloud - even if you have a local caching server on your network) and then revisit the settings and adjust your plans. To clean things up, you will want to sign in to and delete anything you don't want syncing down in the short term.

If you opt in to syncing on one Mac - now you have 4 folders on any one Mac signed in to iCloud - the cloud version of desktop and documents and the local version. Look for confusion around Documents and Desktop.It doesn't do the calculation first - it actually downloads. That means Apple downloads everything and then frees up space when it sees you have little space left. Look for words like 'if there is space' in the description.I think that dialog you have up is pretty clear but based on the last question I would encourage a couple changes in how you're using iCloud.

Backup mac to icloud os catalina