upgrading to new mac with lesser inbuilt drive capacity

How much disk space are you using on the current 2T iMac?

Down sizing is never easy and you generally end up between a rock and a hard place.

IMHO you need room to grow and the best thing to do,

is reduce down to around 350GB before migrating to a 512GB model Mac mini.

or..... to reduce down to around 750GB before migrating to a 1T model Mac mini.

Anything else requires moving your larger Music, Movies and Photos Libraries off to and external drive.

Then using a second external drive to backup the Libraries and/or including them in your Time Machine backups.

At this point, you will have to weight the connivence and price difference, between getting the Mac mini with more internal storage space or having to purchase 1 or 2 more reliable external drives to hold the overflow.

There are people here who suggest that it is best to only transfer your computer preferences, etc. and then do clean installations of current apps. Files can then be manually transferred. Doing so would allow you to put what you wanted where you want it, in either the HD or in the external disk.

FWIW, I keep nearly all my data on an external encrypted drive (with a second drive for backup of course). That includes photos, music, videos, etc. The only data that is kept are things that that are tightly linked to apps, like mail, and the rest is just apps and macOS system files. That gets me down to a very lean system disk. I do have a third, smaller drive as a backup to the internal.

The advantage to this, if you need to wipe and re-install the system or get a new computer, it only takes a short time to retire your apps and settings then you simply plug in the "data drive" and off you go with perhaps some quick linking to libraries on the external drive.

You're welcome.

Yes that will work fine. In fact, you really do not need an ultra fast external drive for your music and photos libraries. The biggest concern here, is to make sure that you have a good backup of both the Mac mini and your libraries.

The decision can also depend on the number and types of apps you have. Unlike the old days where Apps did not carry a lot of support files with them and could run off an non-booting volume, many recent versions, in addition to being larger, require that they be on the boot volume to work at all. I believe you must assume that ALL apps and their support file need to be on the internal drive.

If you've not yet bought the Mini, reconsider storage capacity. Investing in a larger factory SSD now may save you a lot of grief latter.