Many options here, but your goal is smaller files so you can get more on the iPhone. Your best choice is AAC, 256kbps. It's extremely high quality compression, and a format well supported. It beats MP3, and produces much smaller files.
Your challenge here is to decide if you want two libraries, one for your high-rate files, one for the iPhone, or just one library and do everything in AAC 256 only. For 99% of all users I'd suggest one library, AAC 256 (possibly 320bps if you're obsessive). No real need for anything more than that. It just makes life easier to have just one library. Do NOT re-rip your CDS at AAC 256, or convert them within iTunes! You'll end up with a mess on your hands, two versions of everything, and that's very difficult to manage.
Just to satisfy yourself, though, take your best recording, convert it to AAC 256 within iTunes and listen to it. Compare it to the original. You'll be very happy I'm sure.
The nuts and bolts (assuming your on a Mac): To create a fresh iTunes library and not throw out your old one, hold Option key down while launching iTunes, it will ask if you want to create a new library. Be careful to name it something different and pick out a new folder for it. Pick out your new import settings in Preferences > Import Settings > AAC > Custom, pick your bit rate. This setting applies to converting also. Rip away. Importing already imported files does not convert them to the new settings, don't try to cheat! When you're done, sync your iPhone.
The above works on Windows iTunes too, the menu items may be located slightly differently. I also have not updated to the latest iTunes version yet, and I know they changed a bunch of things, but the settings will still be there somewhere. You may be able to find a tool that will batch-convert your files, probably out there, but I've never had to do it. Watch out for converters that convert the file type but drop the meta tags. You'll end up with orphaned files with out any info attached.
One more thing, you've got a pretty good sized iPhone there. I know everyone wants to sync their entire library...I do, but only on my iPod Classic 160. If you're a bit selective about what you sync, you can have most of what you will really play, and re-sync selectively from time to time to mix it up. No re-ripping required for that, just careful sync management and selection. Build some playlists, sync just those for example. My iPhone is only 16gb, and yet I keep quite a bit of entertainment on it. And I never rip anything at less than 320K AAC (because I do have the OCD thing working) so big files, just not all of them all the time.